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Incentives in universal banks

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  • Ugo Albertazzi

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    (Bank of Italy, Economic Research Department)

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    Abstract

    This paper studies the provision of incentives in a universal bank. This is regarded as a (common) agent serving different clients with potentially conflicting interests; for example, it may buy assets on behalf of investors and sell assets on behalf of issuing firms. The clients offer incentive schemes to the bank and they behave non-cooperatively. The bank decides a level of effort and, when firewalls are absent, a level of collusion, modelled as a costly and unproductive redistribution of wealth among the clients. The main conclusion is that in the absence of firewalls the equilibrium incentive schemes are steeper. This means that the level of effort is higher and may compensate the (ex post) inefficiency of collusion. Moreover, this is shown not to hold in the presence of one naive player who does not recognize the existence of the conflict of interest. The model allows to draw conclusions about the desirability of firewalls or of softer measures like the imposition of transparency requirements.

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    File URL: http://www.bancaditalia.it/pubblicazioni/econo/temidi/td06/td572_06/td572/tema_572.pdf
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    Bibliographic Info

    Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 572.

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    Date of creation: Jan 2006
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    Handle: RePEc:bdi:wptemi:td_572_06

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    Web page: http://www.bancaditalia.it
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    Related research

    Keywords: Common Agency; Collusion; Conflicts of Interest; Universal Banks;

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    1. David Martimort & Lars Stole, 2001. "Contractual Externalities and Common Agency Equilibria," CESifo Working Paper Series 581, CESifo Group Munich.
    2. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    3. Martimort, David, 1996. "The multiprincipal nature of government," European Economic Review, Elsevier, vol. 40(3-5), pages 673-685, April.
    4. John H. Boyd & Chun Chang & Bruce D. Smith, 1998. "Moral hazard under commercial and universal banking," Proceedings, Federal Reserve Bank of Cleveland, issue Aug, pages 426-471.
    5. Puri, Manju, 1996. "Commercial banks in investment banking Conflict of interest or certification role?," Journal of Financial Economics, Elsevier, vol. 40(3), pages 373-401, March.
    6. Hoernig, Steffen H., 2002. "Mixed Bertrand equilibria under decreasing returns to scale: an embarrassment of riches," Economics Letters, Elsevier, vol. 74(3), pages 359-362, February.
    7. Randall S. Kroszner & Raghuram G. Rajan, 1995. "Organization Structure and Credibility: Evidence from Commercial Bank Securities Activities Before the Glass-Steagall Act," NBER Working Papers 5256, National Bureau of Economic Research, Inc.
    8. Peters, Michael, 2001. "Common Agency and the Revelation Principle," Econometrica, Econometric Society, vol. 69(5), pages 1349-72, September.
    9. Kofman, Fred & Lawarree, Jacques, 1996. "On the optimality of allowing collusion," Journal of Public Economics, Elsevier, vol. 61(3), pages 383-407, September.
    10. Joel S. Demski, 2003. "Corporate Conflicts of Interest," Journal of Economic Perspectives, American Economic Association, vol. 17(2), pages 51-72, Spring.
    11. Diamond, Douglas W, 1998. "Comment on "Moral Hazard under Commercial and Universal Banking."," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 469-71, August.
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