Lecture 6 and 6A (new)[1] - 9/20/2010 Lecture 6 Economic...

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9/20/2010 1 Lecture 6 Economic Analysis of Banking Regulation And Non-Financial Institutions How Asymmetric Information Explains Banking Regulation 1. Government Safety Net and Deposit Insurance A Prevents bank runs due to asymmetric 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
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9/20/2010 2 3. Bank Capital Requirements A Reduces moral hazard: banks have more to lose How Asymmetric Information Explains Banking Regulation 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 5. New Trend: Assessment of Risk Management 6. Disclosure Requirements A. Better information reduces asymmetric information problem 7. Consumer Protection A Standardized interest rates (APR How Asymmetric Information Explains Banking Regulation A. Standardized interest rates (APR) B. Prevent discrimination: e.g., CRA 8. 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
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9/20/2010 3 Government Safety Net:Too Big to Fail • Government provides guarantees of repayment to large uninsured creditors of the largest financial institutions even when they are not entitled to this guarantee • Uses the purchase and assumption method • Increases moral hazard incentives for big banks Government Safety Net: Financial Consolidation • Larger and more complex financial organizations challenge regulation – Increased “too big to fail” problem – Extends safety net to new activities, increasing incentives for risk taking in these areas (as has occurred during the subprime financial crisis in 2007-2008).
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Lecture 6 and 6A (new)[1] - 9/20/2010 Lecture 6 Economic...

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