BUS
07.1.A1 Lecture Slides Ch.11 - Economic Analysis of Financial Regulation [x1].pptx

07.1.A1 Lecture Slides Ch.11 - Economic Analysis of Financial Regulation [x1].pptx

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Asymmetric Information and Financial Regulation Categories of financial regulation 1. Government safety net 2. Restriction on asset holdings 3. Capital requirements 4. Prompt corrective action 5. Financial supervision: chartering an examination 6. Assessment of risk management 7. Disclosure requirements 8. Consumer protection 9. Restrictions on competition 10. Macro- versus micro-prudential supervision Francesco Marchionne 1
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1) Government safety net: deposit insurance Bank panics and the need for deposit insurance: Bank failure means to get deposit funds after liquidation Depositors are reluctant to put money in bank The sequential service constraint creates bank run Lack of information about bank assets can lead to bank panics . FDIC can short circuits bank failures and contagion effect Francesco Marchionne 2 Purchase and assumption method (reorganize the bank - more costly). [ Full insurance ] Payoff method (failure, pay off deposits up to $250,000, liquidation) [ Partial insurance ]
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1) Government safety net: lender of last resort Francesco Marchionne 3 Other form of government safety net Central bank lends to troubled institutions ( lender of last resort ) Lender of last resort Rescue plans
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1) Government safety net: issues Francesco Marchionne 4 Moral hazard : The insurance provides incentives for risk-taking Depositors do not impose discipline of marketplace on banks. Financial institutions have an incentive to take on greater risk This is the main government concern in providing a safety net. Adverse selection : Risk-lovers find banking attractive Protected depositors do not monitor the financial institution The financial sector attracts crooks because frauds are easier Government intervention is necessary (market failure)
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1) Government safety net: bank size issue Too big to fail A large bank failure could destabilize the economy. Regulator is reluctant to allow a big bank to fail Pay off method : guarantee for small deposit accounts Purchase and assumption method : large capital infusion, merger No incentives to monitor the bank from large depositors Financial consolidation Increase in the too-big-to-fail problem Safety net may be extended to new activities Francesco Marchionne 5
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1) Government safety net: summary Bank panics and the need for deposit insurance: FDIC can short circuits bank failures and contagion effect Payoff method (failure, pay off deposits up to $250,000, liquidation) Purchase and assumption method (reorganize the bank - more costly). Other form of government safety net Central bank lends to troubled institutions ( lender of last resort ) Moral Hazard Depositors do not impose discipline of marketplace.
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  • Spring '14
  • AndreasHauskrecht
  • Basel II, Capital requirement, Bank run, Francesco Marchionne

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