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Looting and risk shifting in banking crises

  • Boyd, John H.
  • Hakenes, Hendrik

We construct a model of the banking firm with inside and outside equity and use it to study bank behavior and regulatory policy during crises. In our model, a bank can increase the risk of its asset portfolio (“risk shift”), convert bank assets to the personal benefit of the bank manager (“loot”), or do both. A regulator has three policy tools: it can restrict the bankʼs investment choices; it can make looting more costly; and it can force banks to hold more equity. Capital regulation may increase looting, and in extreme cases even risk shifting. Looting penalties reduce both looting and risk-shifting.

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 149 (2014)
Issue (Month): C ()
Pages: 43-64

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Handle: RePEc:eee:jetheo:v:149:y:2014:i:c:p:43-64
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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