The role of prudential supervision in a regulated banking industry
This study considers the optimal regulation of a single bank that has private information on the intrinsic quality of its loan portfolio (adverse selection) and where the bank's choice of effort to improve this quality cannot be observed by the banking regulator (moral hazard). In designing optimal contracts the regulator faces a tradeoff between inducing proper incentives for efficient banking and costs of regulation in terms of leaving an informational rent for a high quality bank. As a consequence, the instability of the banking sector increases. To resolve the informational asymmetries the regulator may require the help of a supervising agency, allowing to impose penalties on a bank's management when caught shirking. However, since improving the accuracy of supervision is costly, even in the optimal monitoring scheme there generally exists a positive probability of bankruptcy. Hence, full information disclosure in the sense of improving the supervisor's accuracy to the fullest need not be optimal for the regulator.
|Date of creation:||1999|
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- Kofman, F. & Lawarree, J., 1990.
"Collusion in Hierarchical Agency,"
Discussion Papers in Economics at the University of Washington
91-01, Department of Economics at the University of Washington.
- Eduardo Levy Yeyati & Tito Cordella, 1997.
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IMF Working Papers
97/96, International Monetary Fund.
- Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, March.
- Giammarino, R.M. & Sappington, D.E.M., 1990.
"An Incentive Approach to Banking Regulation,"
367, California Davis - Institute of Governmental Affairs.
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