1 / 13

Banking Regulation: How Asymmetric Information Explains Government Safety Nets and Risk Management

This chapter analyzes how asymmetric information in the banking industry leads to the need for government safety nets, such as deposit insurance, and various regulations to manage risk. It also explores international banking regulation and evaluates the effectiveness of past banking legislation and reforms.

njeanpierre
Download Presentation

Banking Regulation: How Asymmetric Information Explains Government Safety Nets and Risk Management

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. chapter 11 Economic Analysis of Banking Regulation

  2. How Asymmetric InformationExplains Banking Regulation 1. Government Safety Net and Deposit Insurance A. Prevents bank runs due to asymmetric information: depositors can’t tell good from bad banks B. Creates moral hazard incentives for banks to take on too much risk C. Creates adverse selection problem of crooks and risk-takers wanting to control banks D. Too-Big-to-Fail increases moral hazard incentives for big banks 2. Restrictions on Asset Holdings A. Reduces moral hazard of too much risk taking

  3. How Asymmetric InformationExplains Banking Regulation 3. Bank Capital Requirements A. Reduces moral hazard: banks have more to lose when have higher capital B. Higher capital means more collateral for FDIC 4. Bank Supervision: Chartering and Examination A. Reduces adverse selection problem of risk takers or crooks owning banks B. Reduces moral hazard by preventing risky activities C. New trend: Assessment of risk management 5. Disclosure Requirements A. Better information reduces asymmetric information problem

  4. How Asymmetric InformationExplains Banking Regulation 6. Consumer Protection A. Standardized interest rates (APR) B. Prevent discrimination: e.g., CRA 7. Restrictions on Competition to Reduce Risk-Taking A. Branching restrictions B. Separation of banking and securities industries in the past: Glass-Steagall International Banking Regulation 1. Bank regulation abroad similar to ours 2. Particular problem of regulating international banking e.g., BCCI scandal

  5. Major Banking Legislation in U.S.

  6. Major Banking Legislation in U.S.

  7. Why a Banking Crisis in 1980s? Early Stages 1. Decreasing profitability: banks take risk to keep profits up 2. Deregulation in 1980 and 1982, more opportunities for risk taking 3. Innovation of brokered deposits enabled circumvention of $100,000 insurance limit 4. i, net worth of S&Ls  A. Insolvencies  B. Incentives for risk taking  Result: Failures  and risky loans  Later Stages: Regulatory Forbearance 1. Regulators allow insolvent S&Ls to operate because A. Insufficient funds B. Sweep problems under rug C. FHLBB cozy with S&Ls 2. Huge increase in moral hazard for zombie S&Ls: now have incentive to “bet the bank” 3. Zombies hurt healthy S&Ls A. Raise cost of funds B. Lower loan rates 4. Outcome: Huge losses

  8. Political Economy of S&L Crisis Explanation: Principal-Agent Problem 1. Politicians influenced by S&L lobbyists rather than public A. Deny funds to close S&Ls B. Legislation to relax restrictions on S&Ls C. Competitive Bank Equality Act (CEBA) of 1987 had inadequate amount for bailout 2. Regulators influenced by politicians and desire to avoid blame A. Loosened capital requirements B. Regulatory forbearance C. Example: Keating and Lincoln Savings and Loan

  9. Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989 1. New regulatory structure: Office of Thrift Supervision as new regulator, FDIC takes over FSLIC fund 2. Resolution Trust Corporation (RTC) created and given funds to close insolvent S&Ls: cost of $100-$200 billion 3. Core capital requirement  from 3% to 8% 4. Reregulation: Asset restrictions like before 1982

  10. Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 1. FDIC recapitalized with loans and higher premiums 2. Reduce scope of deposit insurance and too-big-to-fail 3. Prompt corrective action provisions 4. Risk-based premiums 5. Annual examinations and stricter reporting 6. Enhances Fed powers to regulate international banking

  11. Evaluating FDICIA and Other Reforms Limits on Scope of Deposit Insurance 1. Eliminate deposit insurance entirely 2. Lower limits on deposit insurance 3. Eliminate too-big-to-fail 4. Coinsurance Prompt Corrective Action 1. Critics believe too many loopholes 2. However: accountability increased by mandatory review of bank failure resolutions Risk-based Insurance Premiums 1. Hard to implement Other Proposed Changes 1. Regulatory consolidation 2. Market-value accounting

  12. Banking Crises Worldwide

  13. Cost of Banking Crises in Other Countries

More Related