Banking stability, reputational rents, and the stock market: should bank regulators care about stock prices?
AbstractIn this paper I begin with a model that generates quantity credit rationing by banks in the spot credit market when the stock market is not doing well, i.e., asset prices are low. Then I provide a theoretical rationale for a bank loan commitment as partial insurance against such future rationing. Incorporating uncertainty about both the creditworthiness of borrowers and the abilities of banks to screen borrowers, I show that the reputational concerns of banks can lead to an equilibrium in which loan commitments serve their role in increasing the supply of credit relative to the spot credit market, but produce the inefficiency of excessive credit supply when the stock market is doing well. Despite this, welfare is higher with loan commitments than with spot credit. ; I use this result to then examine whether the level of the stock market--and more generally asset prices--should matter to bank regulators. My analysis suggests that it should, but not for the usual reason that a bull stock market could trigger inflation. Rather, it is because reputation-concerned banks lend too much during bull markets, leading to a worsening of credit quality and a higher liability for the federal deposit insurer. More stringent stock market information disclosure rules tend to attenuate this distortion and thus deserve consideration by bank regulators. A regulatory policy implication of the analysis is that regulation should be "state-contingent"--regulatory auditing of bank asset portfolios should be more stringent during bull stock markets, or asset pricing bubbles.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Federal Reserve Bank of Boston in its journal Conference Series ; [Proceedings].
Volume (Year): (2002)
Issue (Month): ()
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Shockley Richard L., 1995. "Bank Loan Commitments and Corporate Leverage," Journal of Financial Intermediation, Elsevier, vol. 4(3), pages 272-301, July.
- Morgan, Donald P, 1998. "The Credit Effects of Monetary Policy: Evidence Using Loan Commitments," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(1), pages 102-18, February.
- Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 1999.
"Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking,"
NBER Working Papers
6962, National Bureau of Economic Research, Inc.
- Anil K. Kashyap & Raghuram Rajan & Jeremy C. Stein, 2002. "Banks as Liquidity Providers: An Explanation for the Coexistence of Lending and Deposit-Taking," Journal of Finance, American Finance Association, vol. 57(1), pages 33-73, 02.
- Anil Kashyap & Raghuram Rajan & Jeremy S. Stein, 1998. "Banks as liquidity providers: an explanation for the co-existence of lending and deposit-taking," Proceedings 582, Federal Reserve Bank of Chicago.
- Bengt Holmstrom & I. Ricard & Joan Costa, 1984.
"Managerial Incentives and Capital Management,"
Cowles Foundation Discussion Papers
729, Cowles Foundation for Research in Economics, Yale University.
- John V. Duca & David D. VanHoose, 1988.
"Loan commitments and optimal monetary policy,"
Finance and Economics Discussion Series
44, Board of Governors of the Federal Reserve System (U.S.).
- Giovanni Dell'Ariccia & Ezra Friedman & Robert Marquez, 1999. "Adverse Selection as a Barrier to Entry in the Banking Industry," RAND Journal of Economics, The RAND Corporation, vol. 30(3), pages 515-534, Autumn.
- Dinc, I Serdar, 2000. "Bank Reputation, Bank Commitment, and the Effects of Competition in Credit Markets," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 781-812.
- Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
- Allen, Franklin, 1990. "The market for information and the origin of financial intermediation," Journal of Financial Intermediation, Elsevier, vol. 1(1), pages 3-30, March.
- Boot, Arnoud W A & Thakor, Anjan, 1997.
"Can Relationship Banking Survive Competition?,"
CEPR Discussion Papers
1592, C.E.P.R. Discussion Papers.
- Banks, Jeffrey S & Sobel, Joel, 1987.
"Equilibrium Selection in Signaling Games,"
Econometric Society, vol. 55(3), pages 647-61, May.
- Boot, Arnoud W A & Greenbaum, Stuart I & Thakor, Anjan V, 1993. "Reputation and Discretion in Financial Contracting," American Economic Review, American Economic Association, vol. 83(5), pages 1165-83, December.
- Sharpe, Steven A, 1990.
" Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships,"
Journal of Finance,
American Finance Association, vol. 45(4), pages 1069-87, September.
- Steven A. Sharpe, 1989. "Asymmetric information, bank lending, and implicit contracts: a stylized model of customer relationships," Finance and Economics Discussion Series 70, Board of Governors of the Federal Reserve System (U.S.).
- Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
- Rajan, Raghuram G, 1994. "Why Bank Credit Policies Fluctuate: A Theory and Some Evidence," The Quarterly Journal of Economics, MIT Press, vol. 109(2), pages 399-441, May.
- E. Kohlberg & J.-F. Mertens, 1998.
"On the Strategic Stability of Equilibria,"
Levine's Working Paper Archive
445, David K. Levine.
- Thakor, Anjan V, 1996. " Capital Requirements, Monetary Policy, and Aggregate Bank Lending: Theory and Empirical Evidence," Journal of Finance, American Finance Association, vol. 51(1), pages 279-324, March.
- David Kreps & Robert Wilson, 1998.
Levine's Working Paper Archive
237, David K. Levine.
- Thakor, Anjan V., 2000. "Relationship Banking," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 3-5, January.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Catherine Spozio).
If references are entirely missing, you can add them using this form.