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Moral hazard under commercial and universal banking

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  • John H. Boyd
  • Chun Chang
  • Bruce D. Smith

Abstract

Many claims have been made about the potential benefits, and the potential costs, of adopting a system of universal banking in the United States. We evaluate these claims using a model where there is a moral hazard problem between banks and “borrowers,” a moral hazard problem between banks and a deposit insurer, and a costly state verification problem. Under conditions we describe, allowing banks to take equity positions in firms strengthens their ability to extract surplus, and exacerbates problems of moral hazard. The incentives of universal banks to take equity positions will often be strongest when these problems are most severe.

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Bibliographic Info

Article provided by Federal Reserve Bank of Cleveland in its journal Proceedings.

Volume (Year): (1998)
Issue (Month): Aug ()
Pages: 426-471

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Handle: RePEc:fip:fedcpr:y:1998:i:aug:p:426-471

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Keywords: Universal banks ; Banks and banking;

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References

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  1. Franklin Allen & Douglas Gale, 1994. "A welfare comparison of intermediaries and financial markets in Germany and the U.S," Working Papers 95-3, Federal Reserve Bank of Philadelphia.
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  9. Mitchell Berlin & Kose John & Anthony Saunders, 1995. "Bank equity stakes in borrowing firms and financial distress," Working Papers 96-1, Federal Reserve Bank of Philadelphia.
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  12. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
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