Title: China Walls
Abstract: "Policymakers tightened China Walls (internal controls against conflicts of interest) within all universal banks in response to the Great Recession. By contrast, universal banks were banned altogether after the Great Depression. A key difference between the policymakers’ responses is the prevailing view that China Walls can effectively address the systemic risk inherent to universal banks. We document total compliance with the China Walls by the universal banks. Their Walled-off subsidiaries almost never trade with each other, and little information flow between them. Yet, we find evidence that the China Walls do not reduce systemic risk during crises. The Walled-off subsidiaries faced sharply higher trading costs and traded considerably less than their unrestricted peers in recent liquidity crises. The subsidiaries of large-dealer banks see the greatest increase in trading costs and decrease in trade volumes. Our results add the insights of the literature on financial networks to the debate over universal banking."