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Prudent Banks and Creative Mimics: Can we tell the difference?

Listed author(s):
  • Powell, Andrew

    (Inter American Development Bank)

  • Maier, Antonia

    (University of Warwick)

  • Miller, Marcus

    (University of Warwick)

The recent financial crisis has forced a rethink of banking regulation and supervision and the role of nancial innovation. We develop a model where prudent banks may signal their type through high capital ratios. Capital regulation may ensure separation in equilibrium but deposit insurance will tend to increase the level of capital required. If supervision detects risky behaviour ex ante then it is complementary to capital regulation. However, nancial innovation may erode supervisors' ability to detect risk and capital levels should then be higher. But regulators may not be aware their capacities have been undermined. We argue for a four-prong policy response with higher bank capital ratios, enhanced supervision, limits to the use of complex financial instruments and Coco's. Our results may support the institutional arrangements proposed recently in the UK.

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File URL: http://www2.warwick.ac.uk/fac/soc/economics/research/centres/cage/manage/publications/76.2012_miller.pdf
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Paper provided by Competitive Advantage in the Global Economy (CAGE) in its series CAGE Online Working Paper Series with number 76.

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Date of creation: 2012
Handle: RePEc:cge:wacage:76
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Web page: http://www2.warwick.ac.uk/fac/soc/economics/research/centres/cage/

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  1. Barth,James R. & Caprio,Gerard & Levine,Ross, 2008. "Rethinking Bank Regulation," Cambridge Books, Cambridge University Press, number 9780521709309, December.
  2. Hans-Werner Sinn, 2002. "Risktaking, Limited Liability, and the Competition of Bank Regulators," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 59(3), pages 305-305, August.
  3. David Miles & Jing Yang & Gilberto Marcheggiano, 2013. "Optimal Bank Capital," Economic Journal, Royal Economic Society, vol. 123(567), pages 1-37, 03.
  4. Noldeke, Georg & Samuelson, Larry, 1997. "A Dynamic Model of Equilibrium Selection in Signaling Markets," Journal of Economic Theory, Elsevier, vol. 73(1), pages 118-156, March.
  5. Besancenot, Damien & Vranceanu, Radu, 2011. "Banks' risk race: A signaling explanation," International Review of Economics & Finance, Elsevier, vol. 20(4), pages 784-791, October.
  6. Li, Han Hao & Miller, Marcus & Zhang, Lei, 2011. "When bigger isn’t better: Bail outs and bank behaviour," CEPR Discussion Papers 8602, C.E.P.R. Discussion Papers.
  7. Reint Gropp & Hendrik Hakenes & Isabel Schnabel, 2011. "Competition, Risk-shifting, and Public Bail-out Policies," Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 2084-2120.
  8. Eric S. Maskin, 2008. "Mechanism Design: How to Implement Social Goals," American Economic Review, American Economic Association, vol. 98(3), pages 567-576, June.
  9. Francis A. Longstaff & Arvind Rajan, 2008. "An Empirical Analysis of the Pricing of Collateralized Debt Obligations," Journal of Finance, American Finance Association, vol. 63(2), pages 529-563, April.
  10. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, Oxford University Press, vol. 84(3), pages 488-500.
  11. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  12. Michael Spence, 1973. "Job Market Signaling," The Quarterly Journal of Economics, Oxford University Press, vol. 87(3), pages 355-374.
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