Risktaking, Limited Liability, and the Competition of Bank Regulators
AbstractLimited 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 InfoArticle provided by Mohr Siebeck, Tübingen in its journal FinanzArchiv.
Volume (Year): 59 (2002/2003)
Issue (Month): 3 (August)
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Other versions of this item:
- Hans-Werner Sinn, 2001. "Risk Taking, Limited Liability and the Competition of Bank Regulators," CESifo Working Paper Series 603, CESifo Group Munich.
- Hans-Werner Sinn, 2001. "Risk Taking, Limited Liability and the Competition of Bank Regulators," NBER Working Papers 8669, National Bureau of Economic Research, Inc.
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