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Moral hazard and optimal subsidiary structure for financial institutions

  • Charles M. Kahn
  • Andrew Winton

Banks and related financial institutions often have two separate subsidiaries that make loans of similar type but differing risk, for example, a bank and a finance company, or a "good bank/bad bank" structure. Such "bipartite" structures may prevent risk shifting, in which banks misuse their flexibility in choosing and monitoring loans to exploit their debt holders. By "insulating" safer loans from riskier loans, a bipartite structure reduces risk-shifting incentives in the safer subsidiary. Bipartite structures are more likely to dominate unitary structures as the downside from riskier loans is higher or as expected profits from the efficient loan mix are lower. Copyright 2004 by The American Finance Association.

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Paper provided by Federal Reserve Bank of Chicago in its series Proceedings with number 808.

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Length: 129-149
Date of creation: 2002
Date of revision:
Publication status: Published in Conference on Bank Structure and Competition (2002 : 38th) ; Financial market behavior and appropriate regulation over the business cycle
Handle: RePEc:fip:fedhpr:808
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