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Bank management and market discipline

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  • Landskroner, Yoram
  • Paroush, Jacob
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    Abstract

    In recent years, market discipline has attracted interest as a mechanism to augment or replace government regulation of the financial sector and, especially, depository institutions. The ability to substitute market discipline for bank regulation is of much interest and we use a theoretical model to examine it. In a stylized comprehensive model, we incorporate the characteristics of the regulatory structure and examine the effects of different parameters on the optimal decisions of the bank. These parameters include changes in risk, deposit-insurance coverage, and degree of market discipline. Interesting results include the following: (1) an increase in competition should result in less equity financing, higher deposit interest rates, and higher risk premiums (spreads); (2) exogenous shocks, such as an increase in oil prices, will result in more equity financing; (3) the sensitivity of the two types of deposits will react to a change in market discipline in opposite ways. Our theoretical results are consistent with empirical evidence in recent studies.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economics and Business.

    Volume (Year): 60 (2008)
    Issue (Month): 5 ()
    Pages: 395-414

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    Handle: RePEc:eee:jebusi:v:60:y:2008:i:5:p:395-414

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    Web page: http://www.elsevier.com/locate/jeconbus

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    Keywords: Asset-liability management (ALM) Bank failure Competition Deposits Deposit insurance Equity financing Market discipline Spreads;

    References

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    1. Crockett, Andrew, 2002. "Market discipline and financial stability," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 977-987, May.
    2. John H. Boyd & Gianni De Nicolã, 2005. "The Theory of Bank Risk Taking and Competition Revisited," Journal of Finance, American Finance Association, vol. 60(3), pages 1329-1343, 06.
    3. Diana Hancock & Myron Kwast, 2001. "Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?," Journal of Financial Services Research, Springer, vol. 20(2), pages 147-187, October.
    4. Demirguc-Kunt, Asli & Detragiache, Enrica, 2002. "Does deposit insurance increase banking system stability? An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1373-1406, October.
    5. Park, Sangkyun & Peristiani, Stavros, 1998. "Market Discipline by Thrift Depositors," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 347-64, August.
    6. Blum, Jurg M., 2002. "Subordinated debt, market discipline, and banks' risk taking," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1427-1441, July.
    7. Douglas D. Evanoff & Larry D. Wall, 2001. "Sub-debt yield spreads as bank risk measures," Working Paper 2001-11, Federal Reserve Bank of Atlanta.
    8. Mark Flannery, 2001. "The Faces of “Market Discipline”," Journal of Financial Services Research, Springer, vol. 20(2), pages 107-119, October.
    9. Rong Fan & Joseph G. Haubrich & Peter Ritchken & James B. Thomson, 2003. "Getting the most out of mandatory subordinated debt requirement," Proceedings 848, Federal Reserve Bank of Chicago.
    10. Paroush, Jacob, 1988. " The Domino Effect and the Supervision of the Banking System," Journal of Finance, American Finance Association, vol. 43(5), pages 1207-18, December.
    11. Michael Falkenheim & George Pennacchi, 2003. "The Cost of Deposit Insurance for Privately Held Banks: A Market Comparable Approach," Journal of Financial Services Research, Springer, vol. 24(2), pages 121-148, October.
    12. Sironi, Andrea, 2002. "Strengthening banks' market discipline and leveling the playing field: Are the two compatible?," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 1065-1091, May.
    13. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
    14. Diana Hancock & Myron L. Kwast, 2001. "Using subordinated debt to monitor bank holding companies: is it feasible?," Finance and Economics Discussion Series 2001-22, Board of Governors of the Federal Reserve System (U.S.).
    15. Landskroner, Yoram & Ruthenberg, David, 1985. " Optimal Bank Behavior under Uncertain Inflation," Journal of Finance, American Finance Association, vol. 40(4), pages 1159-71, September.
    16. anonymous, 1999. "Using subordinated debt as an instrument of market discipline," Staff Studies 172, Board of Governors of the Federal Reserve System (U.S.).
    17. Suresh Sundaresan, 2001. "Supervisor and Market Analysts: What Should Research be Seeking?," Journal of Financial Services Research, Springer, vol. 20(2), pages 275-280, October.
    18. A. Sinan Cebenoyan & Elizabeth S. Cooperman & Charles A. Register, 1999. "Ownership Structure, Charter Value, and Risk-Taking Behavior for Thrifts," Financial Management, Financial Management Association, vol. 28(1), Spring.
    19. Donald Morgan & Kevin Stiroh, 2001. "Market Discipline of Banks: The Asset Test," Journal of Financial Services Research, Springer, vol. 20(2), pages 195-208, October.
    20. Flannery, Mark J, 1998. "Using Market Information in Prudential Bank Supervision: A Review of the U.S. Empirical Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 273-305, August.
    21. Landskroner, Yoram & Paroush, Jacob, 1994. "Deposit insurance pricing and social welfare," Journal of Banking & Finance, Elsevier, vol. 18(3), pages 531-552, May.
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    Cited by:
    1. Bouaiss, Karima & Refait-Alexandre, Catherine & Alexandre, Hervé, 2010. "Will Bank Transparency really Help Financial Markets and Regulators?," Economics Papers from University Paris Dauphine 123456789/4060, Paris Dauphine University.

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