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Optimal regulation of a fully insured deposit banking system

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  • Xavier Freixas

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  • Emmanuelle Gabillon

Abstract

We analyze risk sensitive incentive compatible deposit insurance in the presence of private information when the market value of deposit insurance can be determined using Merton's (1997) formula. We show that, under the assumption that transferring funds from taxpayers to financial institutions has a social cost, the optimal regulation combines different levels of capital requirements combined with decreasing premia on deposit insurance. On the other hand, it is never efficient to require the banks to hold riskless assets, so that narrow banking is not efficient. Finally, chartering banks is necessary in order to decrease the cost of asymmetric information.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 175.

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Date of creation: May 1996
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Handle: RePEc:upf:upfgen:175

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Web page: http://www.econ.upf.edu/

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Keywords: Regulation; mechanism design; deposit insurance pricing; capital requirements;

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References

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  1. Avery, Robert B. & Berger, Allen N., 1991. "Risk-based capital and deposit insurance reform," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 847-874, September.
  2. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
  3. Chan, Yuk-Shee & Greenbaum, Stuart I & Thakor, Anjan V, 1992. " Is Fairly Priced Deposit Insurance Possible?," Journal of Finance, American Finance Association, vol. 47(1), pages 227-45, March.
  4. Acharya, Sankarshan & Dreyfus, Jean-Francois, 1989. " Optimal Bank Reorganization Policies and the Pricing of Federal Deposit Insurance," Journal of Finance, American Finance Association, vol. 44(5), pages 1313-33, December.
  5. Berlin, Mitchell & Saunders, Anthony & Udell, Gregory F., 1991. "Deposit insurance reform: What are the issues and what needs to be fixed?," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 735-752, September.
  6. Boot, Arnoud W A & Thakor, Anjan V, 1993. "Self-Interested Bank Regulation," American Economic Review, American Economic Association, vol. 83(2), pages 206-12, May.
  7. Campbell, Tim S. & Chan, Yuk-Shee & Marino, Anthony M., 1992. "An incentive-based theory of bank regulation," Journal of Financial Intermediation, Elsevier, vol. 2(3), pages 255-276, September.
  8. Jean Tirole & Jean-Jaques Laffont, 1985. "Using Cost Observation to Regulate Firms," Working papers 368, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
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  11. Fama, Eugene F., 1980. "Banking in the theory of finance," Journal of Monetary Economics, Elsevier, vol. 6(1), pages 39-57, January.
  12. Lucas, Deborah & McDonald, Robert L., 1987. "Bank portfolio choice with private information about loan quality : Theory and implications for regulation," Journal of Banking & Finance, Elsevier, vol. 11(3), pages 473-497, September.
  13. Buser, Stephen A & Chen, Andrew H & Kane, Edward J, 1981. "Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital," Journal of Finance, American Finance Association, vol. 36(1), pages 51-60, March.
  14. Marcus, Alan J & Shaked, Israel, 1984. "The Valuation of FDIC Deposit Insurance Using Option-pricing Estimates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(4), pages 446-60, November.
  15. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, vol. 25(3), pages 329-369, December.
  16. Giammarino, Ronald M & Lewis, Tracy R & Sappington, David E M, 1993. " An Incentive Approach to Banking Regulation," Journal of Finance, American Finance Association, vol. 48(4), pages 1523-42, September.
  17. 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.
  18. David Pyle, 1984. "Deregulation and deposit insurance reform," Economic Review, Federal Reserve Bank of San Francisco, issue Spr, pages 5-15.
  19. James, Christopher, 1987. "Some evidence on the uniqueness of bank loans," Journal of Financial Economics, Elsevier, vol. 19(2), pages 217-235, December.
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Citations

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Cited by:
  1. Margarita Samartín, 2004. "Algunos Temas Relevantes En La Teoría Bancaria," Documentos de Trabajo de Economía de la Empresa db040403, Universidad Carlos III, Departamento de Economía de la Empresa.
  2. Dag Morten Dalen & Trond Olsen, 2003. "Regulatory Competition and Multi-national Banking," CESifo Working Paper Series 971, CESifo Group Munich.
  3. Xavier Freixas & Anthony M. Santomero, 2002. "An overall perspective on banking regulation," Working Papers 02-1, Federal Reserve Bank of Philadelphia.
  4. Evanoff, Douglas D. & Jagtiani, Julapa A. & Nakata, Taisuke, 2011. "Enhancing market discipline in banking: The role of subordinated debt in financial regulatory reform," Journal of Economics and Business, Elsevier, vol. 63(1), pages 1-22, January.
  5. Sebastián Nieto Parra, 2005. "The Macroeconomic Implications of the New Banking Capital Regulation in Emerging Markets: A Duopoly Model Adapted to Risk-Averse Banks," Sciences Po publications info:hdl:2441/810, Sciences Po.
  6. Georges Dionne, 2003. "The Foundationsof Banks' Risk Regulation: A Review of Literature," THEMA Working Papers 2003-46, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  7. Arup Daripa & Simone Varotto, 2005. "Ex Ante Versus Ex Post Regulation of Bank Capital," Finance 0511009, EconWPA.
  8. Saadaoui, Zied, 2008. "Capital standards and banking stability in emerging countries: an empirical approach," MPRA Paper 25464, University Library of Munich, Germany.
  9. Sebastián Nieto, 2005. "The Macroeconomic Implications of the New Banking Capital Regulation in Emerging Markets: A Duopoly Model Adapted to Risk-Averse Banks," REVISTA DE ECONOMÍA DEL ROSARIO, UNIVERSIDAD DEL ROSARIO.
  10. Franco Fiordelisi & David Marques & Phil Molyneux, 2009. "Efficiency and Risk-Taking in European Banking," Working Papers 09004, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
  11. Arturo Estrella, 2004. "Bank Capital and Risk: Is Voluntary Disclosure Enough?," Journal of Financial Services Research, Springer, vol. 26(2), pages 145-160, October.
  12. João A. C. Santos, 2000. "Bank capital regulation in contemporary banking theory: a review of the literature," BIS Working Papers 90, Bank for International Settlements.

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