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Risktaking, Limited Liability, and the Competition of Bank Regulators

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  • Hans-Werner Sinn

Abstract

Limited liability and asymmetric information between an investment bank and its lenders provide an incentive for a bank to undercapitalize and finance overly risky business projects. To counter this market failure, national governments have imposed solvency constraints on banks. However, these constraints may not survive in systems competition, as systems competition is likely to suffer from the same type of information asymmetry that induced the private market failure and that brought in the government in the first place (Selection Principle). As national solvency regulation creates a positive international policy externality on foreign lenders of domestic banks, there will be an undersupply of such regulation. This may explain why Asian banks were undercapitalized and took excessive risks before the banking crisis emerged.

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Bibliographic Info

Article provided by Mohr Siebeck, Tübingen in its journal FinanzArchiv.

Volume (Year): 59 (2002/2003)
Issue (Month): 3 (August)
Pages: 305-

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Handle: RePEc:mhr:finarc:urn:sici:0015-2218(2002/200308)59:3_305:rllatc_2.0.tx_2-h

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References

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  1. Hyman P. Minsky, 1992. "The Financial Instability Hypothesis," Economics Working Paper Archive wp_74, Levy Economics Institute, The.
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  14. Sinn, Hans-Werner, 1980. "Ökonomische Entscheidungen bei Ungewißheit," Monograph, Mohr Siebeck, Tübingen, edition 1, number urn:isbn:9783169427024, February.
  15. Sinn, Hans-Werner, 1997. "The selection principle and market failure in systems competition," Journal of Public Economics, Elsevier, vol. 66(2), pages 247-274, November.
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  17. Charles W. Calomiris & Andrew Powell, 2000. "Can Emerging Market Bank Regulators Establish Credible Discipline? The Case of Argentina, 1992-1999," NBER Working Papers 7715, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Ralf Ewert & Rainer Niemann, 2010. "Limited Liability, Asymmetric Taxation, and Risk Taking - Why Partial Tax Neutralities can be Harmful," CESifo Working Paper Series 3301, CESifo Group Munich.
  2. Schüler, Martin, 2003. "Incentive Problems in Banking Supervision: The European Case," ZEW Discussion Papers 03-62, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  3. Valeriya Dinger & Sven Steinkamp & Frank Westermann, 2012. "The Tragedy of the Commons and Inflation Bias in the Euro Area," CESifo Working Paper Series 4036, CESifo Group Munich.
  4. International Monetary Fund, 2006. "Regulatory Capture in Banking," IMF Working Papers 06/34, International Monetary Fund.
  5. Hans-Werner Sinn, 2004. "The New Systems Competition," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, vol. 5(1), pages 23-38, 02.
  6. Dag Morten Dalen & Trond Olsen, 2003. "Regulatory Competition and Multi-national Banking," CESifo Working Paper Series 971, CESifo Group Munich.
  7. Giancarlo Corsetti & Michael P. Devereux & John Hassler & Gilles Saint-Paul & Hans-Werner Sinn & Jan-Egbert Sturm & Xavier Vives, 2011. "Chapter 5: Taxation and Regulation of the Financial Sector," EEAG Report on the European Economy, CESifo Group Munich, vol. 0, pages 147-169, 02.
  8. Proto, Eugenio & Sgroi, Daniel, 2012. "Self-Centered Beliefs : An Empirical Approach," The Warwick Economics Research Paper Series (TWERPS) 978, University of Warwick, Department of Economics.
  9. Sharma, Anurag & Jha, Raghbendra, 2012. "Fiscal deficits, banking crises and policy reversal in a semi-open economy," Economic Modelling, Elsevier, vol. 29(2), pages 271-282.
  10. Michael Keen, 2011. "The Taxation and Regulation of Banks," IMF Working Papers 11/206, International Monetary Fund.
  11. Shuyun May Li, 2008. "Costly External Finance, Reallocation, and Aggregate Productivity," Department of Economics - Working Papers Series 1044, The University of Melbourne.
  12. Dell'Ariccia, Giovanni & Marquez, Robert, 2006. "Competition among regulators and credit market integration," Journal of Financial Economics, Elsevier, vol. 79(2), pages 401-430, February.
  13. Damien S.Eldridge & Heajin H.Ryoo & Axel Wieneke, 2012. "Bank Capital Regulation with Asymmetric Countries," Working Papers 2012.08, School of Economics, La Trobe University.
  14. Kersten Kellermann, 2011. "Too big to fail: a thorn in the side of free markets," Empirica, Springer, vol. 38(3), pages 331-349, July.

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