the evolving landscape of banking the structure of the financial services industry is in flux liberalization deregulation and advances in information technology have changed the financial landscape dramatically interbank competition has heated up and banks face increasing competition from nonbanking financial institutions and the financial markets the predictability of the industry with low levels of financial innovation little innovation in distribution channels and well defined and rigid institutional structures is gone product innovations new distribution channels and emerging new competitors are in abundance moreover the subprime crisis that has hit the financial sector in 2007 2008 appears to have a major impact on the structure of the industry this article emphasizes the importance of understanding the economics of banking for assessing the changes in the industry in particular we point at relationship banking as a prime source of the banks comparative advantage the proliferation of transaction oriented banking trading and financial market activities does however seriously challenge relationship banking in order to focus on these issues in a rigorous way we will evaluate the key insights from the relationship banking literature including the potential complementarities and conflicts of interest between intermediated relationship banking activities and financial market underwriting securitization etc activities we also address the issue of the optimal conglomeration of bank activities including the empirical evidence on scope and scale economies we analyze the strategic positioning of banks in the currently highly uncertain competitive arena and link this to the theory of the firm and particularly firm boundaries and learning

risk sharing and contagion in networks we investigate the socially optimal design of financial networks that allows to tackle the trade off between risk sharing and contagion we identify conditions on the shock distribution under which full integration or maximal segmentation is optimal we also show that under different conditions the optimal network displays different levels of strength of linkages to other firms or intermediate degrees of segmentation in the latter case the individual and social incentives to establish linkages are not necessarily aligned when firms face heterogeneous distributions of risks they should optimally form linkages only with firms facing risks of the same kind

what drives deregulation economics and politics of the relaxation of bank branching restrictions this paper investigates private interest public interest and political institutional theories of regulatory change to analyze state level deregulation of bank branching restrictions using a hazard model we find that interest group factors related to the relative strength of potential winners large banks and small bank dependent firms and losers small banks and the rival insurance firms can explain the timing of branching deregulation across states during the last quarter century the same factors also explain congressional voting on interstate branching deregulation while we find some support for each theory the private interest approach provides the most compelling overall explanation of our results

bank regulation and risk taking incentives an international comparison of bank risk abstract this paper uses a panel database of 251 banks in 36 countries to analyze the impact of bank regulation on bank charter value and risk taking after controlling for deposit insurance and for the quality of a country s contracting environment the results indicate that regulatory restrictions increase banks risk taking incentives by reducing their charter value banks in countries with stricter regulation have a lower charter value which increases their incentives to follow risky policies these results corroborate a negative relation between regulatory restrictions and the stability of a banking system deposit insurance has a positive influence on bank charter value mitigating the risk shifting incentives it creates this positive influence disappears when we control for the possible endogeneity of deposit insurance

underwriting by commercial banks incentive conflicts scope economies and project quality the authors study the issue of commercial bank underwriting of securities their analysis examines the incentive conflict faced by intermediaries that both lend and underwrite securities thereby imposing a cost on their customers seeking to raise capital despite this cost firms may choose to use such an intermediary if there are sufficiently large scope economies in combined lending and underwriting the authors demonstrate that the regulatory separation of such combined intermediation may be optimal if firms recognize the intermediary s subsequent incentive conflict when choosing projects to be funded and if there is a social cost to bank funding of poor quality projects they also examine the conditions for intermediaries reputation building to mitigate the incentive conflict without the need for regulation

on the benefits of concurrent lending and underwriting this paper examines whether there are efficiencies that benefit issuers and underwriters when a financial intermediary concurrently lends to an issuer while also underwriting its public securities offering we find issuers particularly noninvestmentgrade issuers for whom informational economies of scope are likely to be large benefit through lower underwriter fees and discounted loan yield spreads underwriters both commercial banks as well as investment banks engage in concurrent lending and provide price discounts albeit in different ways we find concurrent lending helps underwriters build relationships increasing the probability of receiving current and future business for many years the 1933 glass steagall act prevented commercial banks from underwriting corporate bonds and equities due to the relaxation and recent repeal of the act many commercial banks have acquired investment banks or developed investment banking capabilities internally to create universal banks that can offer an array of financial services the entry of commercial banks into underwriting markets has increased the potential for financial institutions to offer both lending and underwriting services in particular it has become increasingly common for financial intermediaries to provide loans to a firm while also underwriting the firm s public securities in fact concurrent lending and underwriting has increased substantially over time in 1994 only 1 of seasoned equity issuers received a loan from their underwriter at around the time of issuance but by 2001 over 20 of all deals were concurrent the movement toward concurrent lending and underwriting raises a host of interesting questions first why are deals concurrent

bond underwriting by banks and conflicts of interest evidence from japan during the pre war period abstract article 65 of the securities and exchange law of japan which was carried into effect in 1948 prohibited banks from underwriting corporate securities partially because of the concern that combining the banking and securities businesses might result in a potential conflict of interest this paper studies the pricing and long term default performance of industrial bonds underwritten by commercial banks the industrial bank of japan ibj and trust firms as compared to those underwritten by investment houses during the pre war period in japan when banks were allowed to underwrite industrial bonds the evidence rejects the concern about the conflicts of interest

is the glass steagall act justified a study of the u s experience with universal banking before the glass steagall act of 1933 removed commercial banks from the securities underwriting business we evaluate the argument for the separation of commercial and investment banking that conflicts of interest induce commercial banks to fool the public into investing in securities which turn out to be of low quality a comparison of the performance of securities underwritten by commercial and investment banks prior to the act shows no evidence of this instead the public appears to have rationally accounted for the possibility of conflicts of interest and this appears to have constrained the banks to underwrite high quality securities jel g21 g24 n22

policy watch government analysis of the benefits and costs of regulation recently congress has shown a greater interest in assessing the economic impact of regulation this interest was driven in part by estimates that federal regulation costs several hundred billion dollars annually in 1996 congress required the director of the office of management and budget to provide estimates of the total annual benefits and costs of individual regulations this essay reviews the increasing use of economic analysis in regulatory decisionmaking critically assesses the first 0mb report and considers how the use of economic analysis can help inform regulatory decisionmaking it argues that policymakers need to address a growing body of evidence that casts doubt on the effectiveness and efficiency of much regulation

the impact of contingent liability on commercial bank risk taking abstract from 1863 1935 regulators imposed contingent liability on bank shareholders to discourage risk taking using data from 1900 to 1915 i find that banks subject to stricter liability rules have lower equity and asset volatility hold a lower proportion of risky assets and are less likely to increase their investment in risky assets when their net worth declines consistent with the hypothesis that stricter liability discourages commercial bank risk taking these findings provide lessons for current bank regulatory policy and show that the shape of the residual claimant s payoff function has a significant impact on managerial incentives and firm performance

welfare gains from financial liberalization financial liberalization has been a controversial issue as empirical evidence for growth enhancing effects is mixed here we find sizable welfare gains from liberalization cost to repression though the gain in economic growth is ambiguous we take the view that financial liberalization is a government policy that alters the path of financial deepening while financial deepening is endogenously chosen by agents given a policy and occurs in transition towards a distant steady state this history dependent view necessitates the use of simulation analysis based on a growth model our application is a specific episode thailand from 1976 to 1996

bank firm relationships financing and firm performance in germany abstract close bank firm relationships that characterize the financial systems in germany and japan are often credited for reducing agency costs and increasing access to capital thus improving the performance of firms critics of these banking systems cite the alternative possibility that conflicts of interests may also arise from both the banks multiple roles with the firm and the opportunity the banks have to use private information to shift risk or to otherwise participate in rent seeking activities we extend the empirical literature by systematically investigating the impact of bank influence on the financing choices and performance of the firm we find that bank influenced firms in germany do benefit from increased access to capital there is however no evidence to support the hypothesis of either higher profitability or growth for bank influenced firms results suggest that the interest payments to debt ratio is significantly higher for bank influenced firms which supports the hypothesis that german universal banks may engage in rent seeking activities and provides evidence of a conflicting interests between creditors and shareholders

moral hazard under commercial and universal banking many claims have been made about the potential benefits and the potential costs of adopting a system of universal banlcing in the united states we evaluate these claims using a model where there is a moral hazard problem between banks and borrowers a moral hazard problem between banks and a deposit insurer and a costly state verification problem under conditions we describe allowing banks to take equity positions in firms strengthens their ability to extract surplus and exacerbates problems of moral hazard the incentives of universal banks to take equity positions will often be strongest when these problems are most severe for many decades commercial banks in the united states have been prohibited from making equity investments in the firms they serve rather they are restricted to providing them with loans in the form essentially of debt contracts this longstanding regulatory restriction1 results in distinctly different roles for bank lenders and equity investors and has had important implications for the entire financial sector the american system of commercial banking presents a sharp contrast with the banking systems of some other countries most notably germany in which banks are permitted to take equity positions under such universal banking arrangements banks can make equity investments as well as loans vote their equity shares and even hold seats on the boards of directors of nonfinancial firms in general they can be actively involved in all aspects of firm decision malqing in germany the control rights the authors have benefitted from the helpful comments of doug diamond joe haubrich ross levine stan longhofer joao santos and an anonymous referee the views expressed herein are those of the authors and not necessarily those of the federal reserve bank of minneapolis or the federal reserve system 1 the key legislation which constrains u s banks equity investments is the glass steagall act of 1933 however a number of other laws also pertain to this issue particularly the bank holding company act of 1956 and its 1970 amendments incidentally there are some important exceptions to the equity investment prohibition in default situations banks are perrnitted to restructure loans into equity positions with the requirement of divestiture after a few years see james 1993 also bank holding companies are permitted to form separately capitalized venture capital subsidiaries for the expressed purpose of investing in start up enterprises john h boyd is a professor of finance in the carlson school of management at the university of minnesota and an adjunct consultant with the federal reserve bank of minneapolis chun chang is an associate professor of finance in the carlson school of management at the university of minnesota bruce d smith is a professor of economics at the university of texas ataustin

lessons from the 1930s great depression this paper provides a survey of the great depression comprising both a narrative account and a detailed review of the empirical evidence focusing especially on the experience of the united states we examine the reasons for and flawed resolution of the american banking crisis as well as the conduct of fiscal and monetary policy we also consider the pivotal role of the gold standard in the international transmission of the slump and leaving gold as a route to recovery policy lessons for today from the great depression are discussed as are some implications for macroeconomics

understanding america s hesitant steps toward financial capitalism politics the depression and the separation of commercial and investment banking few would disagree that the glass steagall act of 1933 is thecontinental divide in american financial and banking history bydisallowing banks from getting involved in the investment bankingindustry this act imposed an institutional change that shaped howfinancial institutions conduct their business even today in itsdecline conventional wisdom has it that the act was enacted tocorrect the deficient financial system that existed during theperiod in this paper we investigate whether this assertion can beempirically verified by analyzing the senate vote on a predecessorof this act which included the clause separating commercialbanking from investment banking activities using multinomiallogits we examine what may have motivated senators to vote for itspassage the econometric evidence indicates that the senate votewas significantly influenced by important interest groups including national banks as well as manufacturing sectorinterests despite the large populist outcry for financial marketreforms at the onset of the depression

banking scope and financial innovation we explore the implications of financial system design for financial innovation we begin with assumptions about the investment opportunities of firms their observable attributes and the roles of commercial banks investment banks and the financial market we examine the borrower s choice between bank and financial market funding the commercial bank s choice of monitoring capacity and the investment bank s choice of whether to invest in financial innovation our main result is that financial innovation in a universal banking system is stochastically lower than innovation in a financial system in which commercial and investment banks are functionally separated article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

systemic risks and the too big to fail problem the financial crisis of 2007 9 resulted in state intervention in financial markets around the world and the state became a major shareholder in many banks while state bailouts were politically sensitive policy makers had little alternative but to supply funds to financial institutions that were viewed as too big to fail or tbtf in this paper i review the history of and the rationale for the tbtf policy i argue that from a policy perspective the most important costs of the tbtf problem are incurred ex ante in the form of distorted incentives that arise as a consequence of distortions to the capital markets and to the choice of banks scale and scope i argue that it is impossible credibly to withdraw the tbtf policy and hence that it should be managed so as to minimize the costs of these distortions in this context i discuss the role of policy in institutional design in the restriction of bank scope and in designing appropriate capital regulations

financial and world economic crisis what did economists contribute in this paper we deal with two questions 1 what are the origins of the current financial crisis and 2 what did economists contribute or why did economists fail to provide a convincing answer for the origins of the crisis and possible solutions to overcome it the economics profession apparently was unaware of the looming worldwide financial and economic crisis and significantly underestimated its global dimensions and consequences a first and preliminary analysis is undertaken to explore reasons for these failures we conclude by pointing to some consequences for economics as well as for economic policy

the influence of the economic approaches to regulation on banking regulations a short history of banking regulations this article highlights the theoretical foundations of the regulations at work in the banking sector and examines their responsibility in the onset of the 2007 2008 financial crisis drawing a parallel between the main changes in banking regulations since the 1960s and the evolutions in the economic analyses of regulation over the same period it shows that the shift from the public interest theory of regulation that prevailed until the late 1960s towards the private interest theory of regulation accounts for the substitution of micro prudential regulations for macro prudential ones and explains a paradigmatic change in the conception of the regulatory instruments of the banking authorities it also shows that although the outcome of several factors the 2007 2008 crisis was also a consequence of the fact that the economic analysis of banking regulations supported micro prudential regulations that fail to take the global features and impact of banking activities into account and have proved unable to recommend effective solutions in a context of crisis

the legal environment banks and long run economic growth this paper examines the relationship between the legal system and banlding development and traces this connection through to long run rates of per capita gdp growth capital stock growth and productivity growth the data indicate that countries where the legal system 1 emphasizes creditor rights and 2 rigorously enforces contracts have better developed banks than countries where laws do not give a high priority to creditors and where enforcement is lax furtherrnore the exogenous component of banking development the component defined by the legal environment is positively and robustly associated with per capita growth physical capital accumulation and productivity growth this paper addresses two questions first do crosscountry differences in the legal rights of creditors the efficiency of contract enforcement and the origin of the legal system explain cross country differences in the level of banking development second do better developed banks cause faster economic development that is is the component of banking development defined by the legal environment positively associated with long run rates of economic growth capital accumulation and productivity growth examining the relationship between the legal system and banking development is valuable irrespective of issues associated with long run growth first banks may influence the level of income per capita and the magnitude of cyclical fluctuations bernanke and gertler 1989 1990 second many economists stress that understanding the evolution of legal and financial systems is essential for understanding economic development north 1981 engerman and sokoloff 1996 consequently quantitative information on the relationship between the legal environment and banks will improve our understanding of business cycles and the process of economic development furthermore examining the causal links between banks and economic growth has both conceptual and policy implications on the conceptual front a long literature debates the importance of banks in economic development starting as early as bagehot 1873 economists have argued that better banks banks that are better at identifying creditworthy firms mobilizing savings pooling risks and facilitating transactions

banking finance and the role of the state this paper provides an overview of the issue it considers the existing structure of financial regulation the deficiencies that were encountered during the financial crisis and the proposed reforms it discusses whether these are likely to be adequate and argues that there are fundamental failures in product markets capital markets and government relations with financial institutions highlighted in the articles in this issue that question whether current reforms will prove sufficient in particular the article argues that a clearly defined partnership between the state and the banking system needs to be established by which the state protects certain core components of the banking system that perform key functions in an economic system and well specified rules are put in place to avoid renegotiation and lobbying copyright 2011 oxford university press

did j p morgan s men add liquidity corporate investment cash flow and financial structure at the turn of the twentieth century this article presents evidence suggesting that the relationship that existed between the partnership of j p morgan and its client firms partially resolved the latter s external financing problems by diminishing the principal agent and asymmetric information problems i estimate and compare investment regression equations for a sample of morgan affiliated companies and a control group of nonaffiliated companies the econometric results seem to indicate that companies not affiliated to the house of morgan were liquidity constrained

a theory of banking structure abstract this paper proposes a theory to analyze the specialization of banking activities based upon the different functions that banks perform when rendering a variety of financial services the functional difference in the services performed by banks is based upon two dimensions the degree of information asymmetry involved in providing the service and the degree of verifiability of the value of the service rendered this has implications for the length of banking relationships and also determines whether banks develop the right degree of skill specialization and resource intensity for the existing task mix costly overspecialization occurs in certain deal type transactions and underspecialization occurs in relationship type transactions the paper examines how bank client relationships are structured and proposes an explanation for phenomena such as bank syndication first mover advantages and monopoly skills are also shown to be natural outcomes of the model the analysis has implications for banking regulation such as for the glass steagall act in the sense that it analyzes the effects of this specialization first enacted within the spirit of the act

asymmetric information in securitization an empirical assessment abstract asymmetric information in securitization deals is analyzed based on a unique dataset comprising a million mortgages both securitized and not and using a methodology previously applied to insurance data that looks at the correlation between risk transfer and default probability the main finding is that for given observable characteristics securitized mortgages have a lower default probability than non securitized ones we show that this finding is consistent with banks caring about their reputation for not selling lemons

presidential address does finance benefit society academics view of the benefits of finance vastly exceeds societal perception this dissonance is at least partly explained by an underappreciation by academia of how without proper rules finance can easily degenerate into a rent seeking activity i outline what finance academics can do from a research point of view and from an educational point of view to promote good finance and minimize the bad

catering to investors through security design headline rate and complexity this study investigates how banks design financial products to cater to yield seeking investors we focus on a large market of investment products targeted exclusively at households retail structured products these products typically offer a high return under their best case scenario the headline rate that is nested in a complex payoff formula using a text analysis of the payoff formulas of the 55 000 products issued in europe from 2002 to 2010 we measure product headline rates complexity and risk over this period product headline rates depart from the prevailing interest rates as the latter decrease complexity increases and risky products become more common in the cross section the headline rate of a product is positively correlated with its level of complexity and risk higher headline rate more complex and riskier products appear more profitable to the banks distributing them our results suggest that financial complexity is a by product of banks catering to yield seeking investors

great crashes in history have they lessons for today crashes in asset markets have been common throughout history while financial crises defined as crises in the banking system have in some countries and periods been as common and in others much more rare this article examines historical attitudes to those events and looks at some of the events themselves it is concluded first that crashes need not inevitably be followed by crises second that crashes without crises do not have serious effects on the economy and third that there is a policy instrument the lender of last resort to prevent financial crises from occurring even should there be a substantial preceding fall in asset markets these lessons from history so it is argued hold for recent events in south east asia and indeed apply generally to any economy the present can still learn from the past copyright 1999 by oxford university press

integration reforms in the european natural gas market a rolling window spillover analysis abstract this paper revisits the topic of natural gas market integration across europe against the backdrop of three eu gas directives aimed at creating competition and strengthening market connections and the move towards hub trading and gas on gas pricing in the european markets we adopt and extend the spillovers index due to diebold and yilmaz 2009 to examine the path of market connectivity over the period between 2005 7 2018 12 an initial estimation uncovers what might be deemed a clunky evolution in the spillover index we identify the cause of this and devise a tilted importance weighting based re sampling rolling window estimation strategy which preserves the underlying evolutionary trend without overly weighting the importance of historic outliers our results show that although there are periods of deterioration the level of market connectivity recovers producing a generally increasing trend of market integration in our sample period the connectivity index peaks at around 65 i e a little above halfway through to full connectivity we conclude that the european natural gas market has achieved a non trivial albeit not full level of integration to date

why regulate insider trading evidence from the first great merger wave 1897 1903 we use event time methodology to study legal insider trading associated with mergers circa 1900 for mergers with prospective disclosures similar to today s we find substantial value gains at announcement implying participation by outside shareholders despite the absence of insider constraints furthermore preannouncement stock price runups relative to total value gain are no more than those observed for modern mergers insider regulation apparently has produced little benefit for outsiders with the inside information pricing function and related gains shifting to external information specialists other results suggest market penalties for nondisclosure i e insider trading is less successful in a restricted information environment

the political economy of the us mortgage default crisis we examine the effects of constituents special interests and ideology on congressional voting on two of the most significant pieces of legislation in us economic history representatives whose constituents experience a sharp increase in mortgage defaults are more likely to support the foreclosure prevention act especially in competitive districts interestingly representatives are more sensitive to defaults of their own party constituents special interests in the form ofhigher campaign contributions from the financial industry increase the likelihood of supporting the emergency economic stabilization act however ideologically conservative representatives are less responsive to both constituent and special interests jel d72 g21 g28

the political economy of branching restrictions and deposit insurance a model of monopolistic competition among small and large banks this article suggests that the introduction of bank branching restrictions and federal deposit insurance in the united states likely was motivated by political considerations specifically we argue that these restrictions were instituted for the benefit of the small unit banks that were unable to compete effectively with large multiunit banks we analyze this political hypothesis in two steps first we use a model of monopolistic competition between small and large banks to examine gains to the former group from the introduction of branching restrictions and governmentsponsored deposit insurance we then find strong evidence for the political hypothesis by examining the voting record of congress

organization structure and credibility evidence from commercial bank securities activities before the glass steagall act we examine the two ways in which us commercial banks organized their investment banking operations before the 1933 glass steagall act forced the banks to leave the securities business as an internal securities department within the bank and as a separately incorporated affiliate with its own board of directors while departments underwrote seemingly higher quality firms and securities than did comparable affiliates the departments obtained lower prices for the issues they underwrote the higher risk premium associated with the internal department is consistent with investors discounting for the greater likelihood of conflicts of interest when lending and underwriting are within the same structure as a result commercial banks evolved toward choosing the separate affiliate structure our results suggest that internal structure is an effective commitment mechanism and absent other distortions market pressures would propel banks to adopt an internal structure that would address regulators concerns about conflicts of interest

the political lessons of depression era banking reform ironically the primary motivations for the main bank regulatory reforms in the 1930s regulation q the separation of investment banking from commercial banking and the creation of federal deposit insurance were to preserve and enhance two of the most disastrous policies that contributed to the severity and depth of the great depression unit banking and the real bills doctrine other regulatory changes affecting the allocation of power between the fed and the treasury were intended to reduce the independence of the fed while giving the opposite impression the ill conceived banking legislation of the 1930s took very little time to pass but a great deal of time to disappear the overarching lesson is that the aftermath of crises are moments of high risk in public policy the great depression provoked banking reform legislation that was quick comprehensive and unusually responsive to popular opinion each of these three aspects increases the risk that regulation will have adverse consequences

housing is local applying a dynamic unobserved factor model for the dutch housing market abstract we employ the multi factor extension of the otrok and whiteman 1998 single dynamic unobserved factor model in order to investigate regional dutch house price fluctuations for the years 1995 2012 this paper is mainly concerned with two questions first is the dutch housing market localized second to which factors can we trace back this localization we find that the dutch housing market is highly localized although there is an important common housing cycle explaining house price comovement across all regions idiosyncratic factors play the most important role although notably group specific factors separating randstad of non randstad regions are only of minor importance nevertheless they can explain region specific housing supply shocks this latter finding can be partly traced back towards an agglomeration effect for randstad regions

interest group competition and the organization of congress theory and evidence from financial services political action committees we develop a positive theory of how interest group competition shapes the organization of congress and use it to explain campaign contribution patterns in financial services since interest groups cannot enforce fee for service contracts with legislators legislators have an incentive to create specialized standing committees which foster repeated dealing between interests and committee members the resulting reputational equilibrium supports high contributions and high legislative effort for the interests contribution patterns by competing interests in the congressional battle over whether banks can enter new businesses support the theory which also has implications for term limits and campaign reform

did banks security affiliates add value evidence from the commercial banking industry during the 1920s this paper finds that banks security affiliates added 4 percent to 7 percent to the market value of commercial banks in 1926 and 1927 this result is robust to the inclusion of a large array of control variables including risk regulatory environment and financial health variables such as the capital asset ratio and profitability measures bank size explains about 40 percent of this premium thus suggesting that economies of scale were present the remaining 60 percent of the premium most likely came from economies of scope this result implies that the glass steagall act by disallowing banks involvement in the securities industry had a direct cost in lost market value for the commercial banking industry