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Moral hazard under commercial and universal banking

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Author Info

  • 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

Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 585.

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Date of creation: 1998
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Publication status: Published in Journal of Money, Credit, and Banking, Part 2 (Vol. 30, No. 3, August 1998, pp. 426-468)
Handle: RePEc:fip:fedmwp:585

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Keywords: Universal banks;

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References

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  1. Saunders, Anthony, 1994. "Banking and commerce: An overview of the public policy issues," Journal of Banking & Finance, Elsevier, vol. 18(2), pages 231-254, January.
  2. George A. Akerlof & Paul M. Romer, 1993. "Looting: The Economic Underworld of Bankruptcy for Profit," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(2), pages 1-74.
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  4. Gertler, M.L. & Hubbard, R.G., 1988. "Financial Factors In Business Fluctuations," Papers fb-_88-37, Columbia - Graduate School of Business.
  5. Boot, Arnoud W A & Thakor, Anjan, 1995. "Financial System Architecture," CEPR Discussion Papers 1197, C.E.P.R. Discussion Papers.
  6. Santos, Joao A. C., 1999. "Bank capital and equity investment regulations," Journal of Banking & Finance, Elsevier, vol. 23(7), pages 1095-1120, July.
  7. Kareken, John H & Wallace, Neil, 1978. "Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition," The Journal of Business, University of Chicago Press, vol. 51(3), pages 413-38, July.
  8. Randall J. Pozdena, 1991. "Why banks need commerce powers," Economic Review, Federal Reserve Bank of San Francisco, issue Sum, pages 18-31.
  9. Gorton, Gary & Schmid, Frank A., 2000. "Universal banking and the performance of German firms," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 29-80.
  10. Allen, Franklin & Gale, Douglas, 1995. "A welfare comparison of intermediaries and financial markets in Germany and the US," European Economic Review, Elsevier, vol. 39(2), pages 179-209, February.
  11. Berlin, Mitchell & John, Kose & Saunders, Anthony, 1996. "Bank Equity Stakes in Borrowing Firms and Financial Distress," Review of Financial Studies, Society for Financial Studies, vol. 9(3), pages 889-919.
  12. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  13. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  14. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
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