The Economics of Bank Regulation

By Bhattacharya, Sudipto; Boot, Arnoud W. A. et al. | Journal of Money, Credit & Banking, November 1998 | Go to article overview

The Economics of Bank Regulation


Bhattacharya, Sudipto, Boot, Arnoud W. A., Thakor, Anjan V., Journal of Money, Credit & Banking


We review the economics of bank regulation as developed in the contemporary literature. We begin with an examination of the central aspects of modern banking theories in explaining the asset transformation function of intermediaries, optimal bank liability contracts, coordination problems leading to bank failures and their empirical significance, and the regulatory interventions suggested by these considerations. In particular, we focus on regulations aimed primarily at ameliorating deposit-insurance-related moral hazards, such as cash-asset reserve requirements, risk-sensitive capital requirements and deposit insurance premia, and bank closure policy. Moreover, we examine the impact of the competitive environment (bank charter value) and industry structure (scope of banks) on these moral hazards. We also examine the implications of banking theory for alternatives to deposit insurance.

The principal objective of this paper is to survey the modern literature on bank regulation, with a focus on exploring the implications of banking theory for optimal regulation. The 1980s and the ongoing 1990s have been witness to exciting developments in banking. On the academic front, the contributions of Leland and Pyle (1977), Diamond (1984), and Ramakrishnan and Thakor (1984) on financial intermediary existence, and those of Bryant (1980) and Diamond and Dybvig (1983) on bank runs and deposit insurance, generated new interest in the microeconomics of financial intermediaries. The new economics of asymmetric information and contract design have helped generate insights about how banks function and are regulated. These insights have been augmented by those in the literatures on credit market functioning under asymmetric information (Bernanke and Gertler 1990; Greenwald and Stiglitz 1990; Stiglitz and Weiss 1981, for example), corporate financing and governance (Myers and Majluf 1984 and Stiglitz 1985), and incomplete contracting (Hart 1991).

During this time governmental regulation of banking has also evolved. In the United States, for example, major banking legislations enacted in the 1930s (for example, the Glass-Steagall Act and the Bank Holding Company Act) have seen important changes. The market-induced "disintermediation" of the 1970s caused regulators to be concerned about the erosion in the competitiveness of banks, and led to the easing of regulatory constraints on banks in the early 1980s. However, the experience with bank deregulation in the 1980s was not entirely pleasant. Many S&L's failed in the late 1980s and early 1990s with total losses exceeding $200 billion, over $2,000 per U.S. household. This has led to a rethinking of the framework of banking regulation, and contemporaneous new regulatory legislation such as the Federal Deposit Insurance Corporation Improvement Act (1991) and the 19818 BIS agreement on capital requirements. In addition, there has been rapid financial innovation, accompanied by an expanding role of financial markets, and this has led to fundamental reconfiguration of the financial services sector; see Berger, Kashyap and Scalise (1995).

Partly due to these developments, many issues in bank regulation remain unresolved, such as these:

   (a) Is deposit contracting (the right to demand withdrawal of contractual
   claims at any point in time from the issuer) important for investor welfare
   on the scale at which it is present in banking today?

   (b) Should deposit insurance continue to be provided for such claims? If
   so, how universal (across intermediaries) and up to what scale should the
   coverage be?

   (c) How should financial intermediaries with insured liabilities be
   regulated? What should be the role of bank capital controls and closure
   rules for troubled institutions?

   (d) What role should the government play in managing idiosyncratic and
   systematic liquidity shocks experienced by banks?

   (e) What should be regulatory policy toward banking scope and interbank
   competition in loan markets? … 

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

The Economics of Bank Regulation
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.