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

bank runs liquidity costs and investment distortions abstract in this paper we extend the diamond and dybvig 1983 model of intermediation to study further the conditions under which bank runs can occur and to consider how private parties might adjust to the existence of bank run equilibria we provide weaker necessary conditions for runs we then characterize how banks respond to the possibility of runs in their design of deposit contracts and investment decisions banks might choose to offer contracts that prevent runs but under some conditions the second best contracts will involve accepting some risk of runs in order to achieve higher expected returns from their investments

banking panics information and rational expectations equilibrium this paper shows that bank runs can be modeled as an equilibrium phenomenon we demonstrate that some aspects of the intuitive story that bank runs start with fears of insolvency of banks can be rigorously modeled if individuals observe long lines at the bank they correctly infer that there is a possibility that the bank is about to fail and precipitate a bank run however bank runs occur even when no one has any adverse information extra market constraints such as suspension of convertibility can prevent bank runs and result in superior allocations banking panics were a recurrent phenomenon in the united states until the 1930s they have re emerged as a source of public concern and much theoretical research recently in this paper we provide an information theoretic rationale for bank runs the traditional story is that contagion is an important aspect of bank runs the idea seems to be that when the general public observes large withdrawals from the banking system fears of insolvency grow resulting in even larger withdrawals of deposits in our model some individuals withdraw because they get information that future returns are likely to be low uninformed individuals observing this also have an incentive to liquidate their investments in addition some individuals need to withdraw deposits for other than informationally based reasons thus if the random realization of such a group of individuals is unusually large then the uninformed individuals will be misled and will precipitate a run on the bank the technology is such that a large volume of withdrawals involves liquidation costs consequently runs on the bank do impose social costs a mechanism that may reduce these costs in our model is to suspend convertibility if withdrawals are high however those individuals who need to withdraw their assets for liquidity reasons are worse off ex post our model provides a rationalization for restrictions in demand deposits that were widespread prior to 1929 friedman and schwartz 7 suggest that restrictions of payments ensured

a real options approach to bankruptcy costs evidence from failed commercial banks during the 1990s literature identifies three main aspects of liquidation costs firm size asset specificity and industry concentration this paper unifies the theory behind these aspects of bankruptcy costs by treating them as components of a broader option valuation problem faced by the liquidating trustee testing the hypothesized asset price relationships on fdic failed bank liquidation data yields the appropriate results furthermore it appears that liquidation time alone can be used as an effective second order proxy for asset value growth where market value estimates are unavailable

deposit insurance and money market freezes in the presence of deposit insurance a rise in counterparty risk may cause a freeze in interbank money markets we show this in a general equilibrium model with regionally segmented bank based retail financial markets in which money markets facilitate the reallocation of funds across banks from different regions counterparty risk creates an asymmetry between banks in savings rich regions which remain marginally financed by the abundant regional insured deposits and in savings poor regions which have to pay large spreads in money markets this asymmetry distorts the aggregate allocation of credit and in the presence of demand externalities can cause large output losses

lender screening and the role of securitization evidence from prime and subprime mortgage markets this article examines the link between mortgage securitization and lender screening during the boom and bust of the u s housing market using comprehensive data on both prime and subprime securitized and bank held loans we provide evidence that securitization affected lenders screening decisions in the subprime market for low documentation loans through two channels the securitization rate and the time it takes to securitize a loan the change in decision making by subprime lenders occurs on dimensions that are unreported to investors examining the time series evolution of the securitization market further reinforces these findings we exploit heterogeneity across subprime and prime markets to illustrate that the potential for moral hazard may be reduced with greater collection of hard information and increased monitoring of lenders our results suggest that the policy debate regarding securitization and lenders underwriting standards should separately evaluate the agency and non agency markets with special attention toward the extent of soft information in assets being securitized the author 2012 published by oxford university press on behalf of the society for financial studies all rights reserved for permissions please e mail journals permissions oup com oxford university press

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

distinguishing panics and information based bank runs welfare and policy implications in this paper we contrast panics and information based bank runs in an effort to provide a robust and empirically plausible model of how bank runs are triggered the model of information based runs is characterized by two sided asymmetric information the bank cannot observe the true liquidity needs of the depositors while depositors are asymmetrically informed about bank asset quality we also examine the relative degrees of risk sharing provided by bank deposit contracts and traded equity contracts we show that the choice of deposit or equity depends on the attributes of and information about the underlying investment returns

the effects of business models on bank risk before during and after financial crisis evidence from china using chinese data from 2004 to 2016 we investigate the effects of business models on bank risk before during and after financial crisis three main results emerge first insolvency risk and roa

the fragile capital structure of hedge funds and the limits to arbitrage abstract during a financial crisis when investors are most in need of liquidity and accurate prices hedge funds cut their arbitrage positions and hoard cash the paper explains this phenomenon we argue that the fragile nature of the capital structure of hedge funds combined with low market liquidity creates a risk of coordination in redemptions among hedge fund investors that severely limits hedge funds arbitrage capabilities we present a model of hedge funds optimal asset allocation in the presence of coordination risk among investors we show that hedge fund managers behave conservatively and even abstain from participating in the market once coordination risk is factored into their investment decisions the model suggests a new source of limits to arbitrage

reflections on northern rock the bank run that heralded the global financial crisis in september 2007 television viewers and newspaper readers around the world saw pictures of what looked like an old fashioned bank run that is depositors waiting in line outside the branch offices of a united kingdom bank called northern rock to withdraw their money the previous u k bank run before northern rock was in 1866 at overend gurney a london bank that overreached itself in the railway and docks boom of the 1860s bank runs were not uncommon in the united states up through the 1930s but they have been rare since the start of deposit insurance backed by the federal deposit insurance corporation in contrast deposit insurance in the united kingdom was a partial affair funded by the banking industry itself and insuring only a part of the deposits at the time of the run u k bank deposits were fully insured only up to 2 000 pounds and then only 90 percent of the deposits up to an upper limit of 35 000 pounds when faced with a run the incentive to withdraw one s deposits from a u k bank was therefore very strong for economists the run on northern rock at first seemed to offer a rare opportunity to study at close quarters all the elements involved in their theoretical models of bank runs the futility of public statements of reassurance the mutually reinforcing anxiety of depositors as well as the power of the media in galvanizing and channeling that anxiety through the power of television images however the storyline of the northern rock bank run does not fit the conventional narrative on september 13 2007 the bbc s evening television news broadcast first broke the news that northern rock had sought the bank of england s support the next morning the bank of england announced that it would provide emergency liquidity support it was only after that announcement that is after the

financial regulation and securitization evidence from subprime mortgage loans we examine the consequences of existing regulations on the quality of mortgage loans originations in the originate to distribute otd market the information asymmetries in the otd market can lead to moral hazard problems on the part of lenders we find using a plausibly exogenous source of variation in the ease of securitization that the quality of loan origination varies inversely with the amount of regulation more regulated lenders originate loans of worse quality we interpret this result as a possible evidence that the fragility of lightly regulated originators capital structure can mitigate moral hazard in addition we find that incentives which require mortgage brokers to have skin in the game and stronger risk management departments inside the bank partially alleviate the moral hazard problem in this setting finally having more lenders inside a mortgage pool is associated with higher quality loans suggesting that sharper relative performance evaluation made possible by more competition among contributing lenders can also mitigate the moral hazard problem to some extent overall our evidence suggests that market forces rather than regulation may have been more effective in mitigating moral hazard in the otd market the findings caution against policies that impose stricter lender regulations which fail to align lenders incentives with the investors of mortgage backed securities 2009 elsevier b v all rights reserved

optimal financial crises empirical evidence suggests that banking panics are related to the business cycle and are not simply the result of sunspots panics occur when depositors perceive that the returns on bank assets are going to be unusually low we develop a simple model of this in this setting bank runs can be first best efficient they allow efficient risk sharing between early and late withdrawing depositors and they allow banks to hold efficient portfolios however if costly runs or markets for risky assets are introduced central bank intervention of the right kind can lead to a pareto improvement in welfare from the earliest times banks have been plagued by the problem of bank runs in which many or all of the bank s depositors attempt to withdraw their funds simultaneously because banks issue liquid liabilities in the form of deposit contracts but invest in illiquid assets in the form of loans they are vulnerable to runs that can lead to closure and liquidation a financial crisis or banking panic occurs when depositors at many or all of the banks in a region or a country attempt to withdraw their funds simultaneously prior to the twentieth century banking panics occurred frequently in europe and the united states panics were generally regarded as a bad thing and the development of central banks to eliminate panics and ensure financial stability has been an important feature of the history of financial systems it has been a long and involved process the first cerntral bank the bank of sweden was established more than 300 years ago the bank of england played an especially important role in the development of effective stabilization policies in the eighteenth and nineteenth centuries by the end of the nineteenth century banking panics had been eliminated in europe the last true panic in england was the overend gurney company crisis of 1866

do banks have a future abstract are banks special intermediaries do they play any unique role in the economy and if so will they retain their specialness in the ever faster changing world of finance the rapid evolution of finance over the last two decades and the breathtaking e age revolution have persuaded many that eventually banks will be indistinguishable from other financial intermediaries since all their functions can at least as efficiently be carried out by nonbanks this study re explores the issue of the specialness of banks in light of the large existing literature on the subject and presents an approach which identifies the banks specialness with their unique capacity to lend out claims on their own debt which the public accepts and uses as money the study discusses various structural and policy implications deriving from the approach and draws on it to point to the continuing relevance of banking in a world where nonbanks are taking business away from banks lending to production has become relatively less important and the use of e money may soon be dominating financial transactions

externalities and bargaining disagreement abstract we examine the possibility of disagreement in a one period bargaining model with positive externalities we find that when the externalities are relatively small no such disagreements can arise i e there are no ex post bargaining inefficiencies if however the externalities are large enough then disagreements occur with a positive probability

what factors drive systemic risk during international financial crises abstract we analyze the determinants of the contribution of international banks to both global and local systemic risk during prominent financial crises we find no empirical evidence supporting conjectures that bank size leverage non interest income or the quality of the bank s credit portfolio are persistent determinants of systemic risk across financial crises in contrast our results show that global systemic risk in particular is predominantly driven by characteristics of the regulatory regime we also confirm for the subprime crisis that the banks contribution to moderately bad tail events in the past predicts the financial sector s crash risk

financial intermediation and delegated monitoring this paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders it presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary diversification within an intermediary serves to reduce these costs even in a risk neutral economy the paper presents some more general analysis of the effect of diversification on resolving incentive problems in the environment assumed in the model debt contracts with costly bankruptcy are shown to be optimal the analysis has implications for the portfolio structure and capital structure of intermediaries

uninsured deposits as a monitoring device their impact on bond yields of banks abstract we empirically analyze the impact of uninsured deposits on a bank s cost of public debt uninsured depositors can exert market discipline over a bank and potentially reduce its agency cost of debt through informed monitoring we use a sample of public bond issues by u s bank holding companies from 1994 to 2013 and find statistically strong evidence that banks with more uninsured deposits relative to their assets issue bonds with a lower interest rate findings suggest a one standard deviation increase in uninsured deposits is associated with a 46 64 basis point decrease in bond yield in addition we find that bonds issued by banks with higher default risk or lower reputation benefit more from uninsured savers our paper contributes to the literature that explores market discipline and provides evidence that banks can benefit from it through a lower borrowing cost

delegated monitors large and small germany s banking system 1800 1914 banks play a greater role in the german financial system than in those of the united states or britain germany s large universal banks are admired by those who advocate bank deregulation in the united states others admire the universal banks for their supposed role in corporate governance and industrial finance many discussions distort the german banking system by overstressing one of several types of banks and ignore the competition and cooperation between the famous universal banks and other banking groups tracing the historical development of the german banking system from the early nineteenth century places the large universal banks in context

the role of demandable debt in structuring optimal banking arrangements demandable debt finance by banks warrants explanation because it entails costs of bank suspension liquidation and idle reserve holdings an explanation is developed in which demandable debt provides incentive compatible intermediation where the banker has comparative advantage in allocating investment funds but may act against the interests of uninformed depositors demandable debt attracts funds by giving depositors an option to force liquidation its usefulness in transacting follows from information sharing between monitors and nonmonitors copyright 1991 by american economic association

the shadow costs of repos and bank liability structure making use of a structural model that allows for optimal liquidity management we study the role that repos play in a bank s financing structure in our model the bank s assets consist of illiquid loans and liquid reserves and are financed by a combination of repos long term debt deposits and equity repos are a cheap source of funding but they are subject to an exogenous rollover risk we show that the use of repos inflicts two types of indirect shadow costs on the bank s shareholders first it induces the bank to maintain higher liquid reserves in order to alleviate the additional default risk second it adds to the cost of long term debt financing these shadow costs limit the bank s appetite for cheap but unstable repo funding this effect is however weakened under poor returns on risky assets access to deposit funding and the depositor preference rule we also analyze the impact of a liquidity coverage ratio payout restrictions and a leverage ratio on the bank s financing choices and show that all these tools are able to curb the bank s reliance on repos

intertemporal diversification in financial intermediation abstract this paper examines the incentive problem between a bank and depositors or deposit insurer limited liability makes risk shifting lucrative we show how intertemporal diversification of lending decisions i e bank s loan portfolio consists of overlapping long term loans and is thus gradually renewed may solve the incentive problem of risk shifting a new or expanding bank sets a high equity level and acquires depositors confidence subsequently it can allow its equity to depreciate to a permanently lower level depositors can control the bank by monitoring equity and realized credit losses ex post they do not have to monitor bank s lending choices ex ante maturity mismatch illiquidity of long term loans and liquidity of deposits is optimal the analysis can be extended more generally to the borrower lender relationship

the hazards of debt rollover freezes incentives and bailouts we investigate the trade o between incentive provision an di ne ient rollover freezes for a firm financed with short term debt first debt maturity that is too short term is ine cient even with incentive provision th eo ptimal maturity is an interior solution that avoids excessive rollover risk whil ep roviding su ient incentives for the manager to avoid risk shifting when the firm is in good health second allowing the manager to risk shift during a freeze actually increase sc reditor conf idence debt policy should not prevent the manager from holding what may appear to be otherwise low mean strategies that have option value during a freeze third a limited but not perfectly reliable form of emergency financing during a freeze a bailout may improve the terms of the trade o and increase total ex ante va lue by instilling confidence in the creditor markets our conclusions highlight the endogenous interaction between risk from the asset and liability sides of the balance sheet

free banking and information asymmetry a traditional argument against free banking is that it will collapse because of information externalities it is impossible for depositors to tell whether a high deposit rate offered by a bank is due to its high efficiency or risky lending strategy this paper shows that in a separating equilibrium a higher quality bank offers a lower deposit rate and holds a smaller proportion of risky loans than a lower quality bank to signal its underlying quality hence free banking is not inherently unstable the empirical results for the hong kong banking system during 1964 65 are consistent with the hypothesis of a separating equilibrium

income tax evasion labour supply and the equity efficiency tradeoff abstract this paper is an attempt to incorporate tax evasion into the analysis of optimum income taxation a model of variable labour supply with tax evasion is used to derive supply functions for labour in regular and irregular markets given taxpayer behaviour the government chooses tax rates penalties and the probability of detection to maximize a utilitarian social welfare function the results consist in the derivation of a formula for the optimum marginal tax rate and a characterization of the factors determining the choice between the penalty rate and the probability of detection as instruments for the control of tax evasion

building an incentive compatible safety net abstract bank safety nets originally proposed as a means of stabilizing financial systems have become an important destabilizing influence government protection of bank debts encourages banks to undertake excessive risk particularly in response to adverse shocks to asset values reforms that would remove the destabilizing moral hazard consequences of government protection are considered both from the perspective of economic desirability and political feasibility requiring banks to maintain a minimal proportion of subordinated debt finance and restricting the means by which government recapitalization of insolvent banks occurs are the central features of promising reforms to the safety net

the role of interbank markets in monetary policy a model with rationing the empirical research on monetary transmission has reported a number of puzzles challenging extant theoretical models of the transmission mechanism in this paper we argue that asymmetric information in the interbank market may be important to have a better understanding of the mechanisms at work in the transmission process we show that asymmetric information may induce an equilibrium with rationing this in turn has two major implications first it reconciles the apparent irresponsiveness of business investment to the user cost of capital with the large impact of monetary policy magnitude puzzle and second it shows that this impact will not be limited to short term credit supply but will also affect long term lending even if the corresponding interest rate is unaffected composition puzzle

the life cycle of a microfinance institution the irish loan funds abstract ireland s loan funds were a long lived self sustaining large scale microfinance organization that made millions of loans without collateral to the poor during the first 100 years of their life cycle a period of growth ending in the 1840s they adapted constantly and obtained improvements to their legal structure because they were complementary to the banking system and seen as effective in relieving poverty in their 2nd century they became ossified in part because of competition with commercial banks the loan funds provide an example of sustainable microfinance under harsh economic conditions and illustrate how organizations change incrementally and when successful alter their institutional framework

bank runs deposit insurance and capital requirements diamond and dybvig provide a model of intermediation in which deposit insurance can avoid socially undesirable bank runs we extend the diamond dybvig model to evaluate the costs and benefits of deposit insurance in the presence of moral hazard by banks and monitoring by depositors we find that complete deposit insurance alone will not support the first best outcome depositors will not have adequate incentives for monitoring and banks will invest in excessively risky projects however an additional capital requirement for banks can restore the first best allocation

strategic loan defaults and coordination an experimental analysis this paper experimentally studies the impact of bank and borrower fundamentals on loan repayment we find that solvent borrowers are more likely to default strategically when the bank s expected strength is low although loan repayment is a pareto dominant nash equilibrium borrowers are also less likely to repay when other borrowers expected repayment capacity is low regardless of banks fundamentals we show that changes in expectations about bank and borrower fundamentals change the risk dominance properties of the borrowers coordination problem and that these changes subsequently explain strategic defaults for the individual borrower loss aversion and negative past experiences reduce repayment suggesting that bank failure can be contagious in times of distress

interbank contagion at work evidence from a natural experiment this article tests financial contagion due to interbank linkages for identification we exploit an idiosyncratic sudden shock caused by a large bank failure in conjunction with detailed data on interbank exposures first we find robust evidence that higher interbank exposure to the failed bank leads to large deposit withdrawals second the magnitude of contagion is higher for banks with weaker fundamentals third interbank linkages among surviving banks further propagate the shock finally we find results suggesting that there are real economic effects these results suggest that interbank linkages act as an important channel of contagion and hold important policy implications jel g01 g21 g28 e58 since the onset of the financial turmoil increased uncertainty reflected particularly in counterparty risk has led banks to hoard liquidity this has resulted in a significant decline of trading in the interbank money markets jean claude trichet president of the european central bank december 2008

debt financing in asset markets short term debt such as overnight repurchase agreements and commercial paper was heavily used by financial institutions to fund their investment positions during the asset market boom preceding the financial crisis of 2007 2008 and later played a major role in leading to the distress of these institutions during the crisis what explains the popularity of short term debt in financing asset market investments geanakoplos 2010 presents a dynamic model of the joint equilibrium of asset markets and credit markets in which optimistic buyers of a risky asset use the asset as collateral to raise debt financing from less optimistic creditors the asset s collateral value depends on the marginal creditor s asset valuation and determines the buyers purchasing capacity to bid up the asset price geanakoplos posits that short term debt allows the asset buyers to maximize riskless leverage 1 short term debt however exposes the asset buyers to rollover risk e g acharya gale and yorulmaker 2011 and he and xiong 2012 forthcoming which is reflected in the fact that the asset buyers in geanakoplos model may not be able to obtain refinancing after a negative fundamental shock as a result they are forced to transfer their asset holdings to the

who borrows from the lender of last resort understanding why banks borrow from the lender of last resort lolr during a nancial crisis is crucial to understanding the macroeconomic impact of such largescale interventions we document a strong divergence among banks take up of lolr assistance during the nancial crisis in the euro area as banks which borrowed heavily also used increasingly risky collateral we propose four explanations for this divergence