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Banking Regulation without Commitment to Audit

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Author Info
Patrick Leoni
Abstract

We consider a regulator providing deposit insurance to a bank with private information about its investment portfolio. As typical in practice, we assume that the regulator does not commit to auditing after any risk report from the bank. We first show that the optimal contract can be implemented through a direct revelation mechanism. We also show that, at the optimal contract, a high risk bank has incentives to misreport. We thus establish that extraction of truthful risk information, as done in current regulatory practice, is not compatible with the maximization of social welfare.

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Paper provided by Institute for Empirical Research in Economics - IEW in its series IEW - Working Papers with number iewwp251.

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Handle: RePEc:zur:iewwpx:251

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Related research
Keywords: Banking Regulation; Partial Commitment; Asymmetric Information; Adverse Selection;

Find related papers by JEL classification:
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

References listed on IDEAS
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  1. Helmut Bester & Roland Strausz, . "Imperfect Commitment and the Revelation Principle," Papers 004, Departmental Working Papers. [Downloadable!]
  2. 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. [Downloadable!] (restricted)
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  3. 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. [Downloadable!] (restricted)
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  4. Fahad Khalil, 1997. "Auditing Without Commitment," RAND Journal of Economics, The RAND Corporation, vol. 28(4), pages 629-640, Winter. [Downloadable!] (restricted)
  5. Ballard, Charles L & Shoven, John B & Whalley, John, 1985. "General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States," American Economic Review, American Economic Association, vol. 75(1), pages 128-38, March. [Downloadable!] (restricted)
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This page was last updated on 2009-12-17.

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