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Risk Taking, 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 undercapitalise 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 which induced the private market failure and which 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 undercapitalised and took excessive risks before the banking crisis emerged.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8669.

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Date of creation: Dec 2001
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Publication status: published as Hans-Werner Sinn, 2002. "Risktaking, Limited Liability, and the Competition of Bank Regulators," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 59(3), pages 305-, August.
Handle: RePEc:nbr:nberwo:8669

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  1. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, American Economic Association, vol. 71(3), pages 393-410, June.
  2. Sinn, Hans-Werner, 1982. "Kinked utility and the demand for human wealth and liability insurance," European Economic Review, Elsevier, Elsevier, vol. 17(2), pages 149-162.
  3. Kenneth Kletzer & Robert Dekle, 2001. "Domestic Bank Regulation and Financial Crises," IMF Working Papers 01/63, International Monetary Fund.
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  9. Sinn, Hans-Werner, 1997. "The selection principle and market failure in systems competition," Munich Reprints in Economics, University of Munich, Department of Economics 19854, University of Munich, Department of Economics.
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  12. Sinn, Hans-Werner, 1980. "Ökonomische Entscheidungen bei Ungewißheit," Monograph, Mohr Siebeck, Tübingen, Mohr Siebeck, Tübingen, edition 1, number urn:isbn:9783169427024, February.
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  15. 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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Cited by:
  1. Dell'Ariccia, Giovanni & Marquez, Robert, 2006. "Competition among regulators and credit market integration," Journal of Financial Economics, Elsevier, Elsevier, vol. 79(2), pages 401-430, February.
  2. Sinn, Hans-Werner, 2004. "The new systems competition," Munich Reprints in Economics, University of Munich, Department of Economics 19608, University of Munich, Department of Economics.
  3. Dinger, Valeriya & Steinkamp, Sven & Westermann, Frank, 2012. "The Tragedy of the Commons and Inflation Bias in the Euro Area," Working Papers, Institute of Empirical Economic Research 94, Institute of Empirical Economic Research.
  4. Andrew Powell & Marcus Miller & Antonia Maier, 2011. "Prudent Banks and Creative Mimics: Can We Tell the Difference?," Research Department Publications, Inter-American Development Bank, Research Department 4760, Inter-American Development Bank, Research Department.
  5. Michael Keen, 2011. "The Taxation and Regulation of Banks," IMF Working Papers 11/206, International Monetary Fund.
  6. Shuyun May Li, 2008. "Costly External Finance, Reallocation, and Aggregate Productivity," Department of Economics - Working Papers Series, The University of Melbourne 1044, The University of Melbourne.
  7. 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.
  8. Schüler, Martin, 2003. "Incentive Problems in Banking Supervision: The European Case," ZEW Discussion Papers, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research 03-62, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  9. Maier, Ulf & Haufler, Andreas, 2013. "Regulatory competition in credit markets with capital standards as signals," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79769, Verein für Socialpolitik / German Economic Association.
  10. Eberl, Jakob & Jus, Darko, 2012. "The year of the cat: Taxing nuclear risk with the help of capital markets," Energy Policy, Elsevier, Elsevier, vol. 51(C), pages 364-373.
  11. Kersten Kellermann, 2011. "Too big to fail: a thorn in the side of free markets," Empirica, Springer, Springer, vol. 38(3), pages 331-349, July.
  12. 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, CESifo Group Munich, vol. 0, pages 147-169, 02.
  13. Sharma, Anurag & Jha, Raghbendra, 2012. "Fiscal deficits, banking crises and policy reversal in a semi-open economy," Economic Modelling, Elsevier, Elsevier, vol. 29(2), pages 271-282.
  14. Damien S.Eldridge & Heajin H.Ryoo & Axel Wieneke, 2012. "Bank Capital Regulation with Asymmetric Countries," Working Papers, School of Economics, La Trobe University 2012.08, School of Economics, La Trobe University.
  15. Jakob Eberl & Darko Jus, 2012. "Evaluating policies to attain the optimal exposure to nuclear risk," RSCAS Working Papers, European University Institute 2012/50, European University Institute.
  16. International Monetary Fund, 2006. "Regulatory Capture in Banking," IMF Working Papers 06/34, International Monetary Fund.
  17. Dag Morten Dalen & Trond Olsen, 2003. "Regulatory Competition and Multi-national Banking," CESifo Working Paper Series 971, CESifo Group Munich.

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