We present a model of an economy with heterogeneous banks that may be funded with uninsured deposits and equity capital. Capital serves to ameliorate a moral hazard problem in the choice of risk. There is a fixed aggregate supply of bank capital, so the cost of capital is endogenous. A regulator sets risk-sensitive capital requirements in order to maximize a social welfare function that incorporates a social cost of bank failure. We consider the effect of a negative shock to the supply of bank capital and show that optimal capital requirements should be lowered. Failure to do so would keep banks safer but produce a large reduction in aggregate investment. The result provides a rationale for the cyclical adjustment of risk-sensitive capital requirements.

This paper presents a dynamic model of imperfect competition in banking where the banks can invest in a prudent or a gambling asset. We show that if intermediation margins are small, the banks' franchise values will be small, and in the absence of regulation only a gambling equilibrium will exist. In this case, either flat-rate capital requirements or binding deposit rate ceilings can ensure the existence of a prudent equilibrium, although both have a negative impact on deposit rates. Such impact does not obtain with either risk-based capital requirements or nonbinding deposit rate ceilings, but only the former are always effective in controlling risk-shifting incentives.

This paper defines a new concept of the core for an economy with transaction costs, and uses this concept to prove a limit theorem for sequences of replica economies. In this way it provides a rationale for a definition of equilibrium in which agents face a sequence of budget constraints. Since economies with incomplete markets are special cases of economies with transaction costs, the limit theorem also provides a rationale for Radner's equilibrium of plans, prices, and price expectations.

This paper shows that if a social choice rule can be implemented in dominant strategies by an indirect mechanism, but there does not exist a direct mechanism that implements it in dominant strategies, then it must be the case that the original indirect mechanism does not implement the social choice rule in Nash strategies (under complete information) or in Bayesian strategies (under imcomplete information).

Journal Article A Note on Imperfect Information and Optimal Pollution Control Get access Rafael Repullo Rafael Repullo London School of Economics Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 49, Issue 3, July 1982, Pages 483–484, https://doi.org/10.2307/2297372 Published: 01 July 1982

We present a model of the maturity of a bank’s uninsured debt. The bank borrows to invest in a long-term asset with endogenous and nonverifiable risk. This moral hazard problem leads to excessive risk-taking. Short-term debt may have a disciplining effect on risk-taking, but it may lead to overborrowing and/or inefficient liquidation. We characterize the conditions under which short- and long-term debt are feasible, and show circumstances where only short-term debt is feasible and where short-term debt dominates long-term debt when both are feasible. The results are consistent with some features of the period preceding the 2007-2009 global financial crisis.

We analyze the loan pricing implications of the reform of bank capital regulation known as Basel II. We consider a perfectly competitive market for business loans where, as in the model underlying the internal ratings based (IRB) approach of Basel II, a single risk factor explains the correlation in defaults across firms. Our loan pricing equation implies that low risk firms will achieve reductions in their loan rates by borrowing from banks adopting the IRB approach, while high risk firms will avoid increases in their loan rates by borrowing from banks that adopt the less risk-sensitive standardized approach of Basel II. We also show that only a very high social cost of bank failure might justify the proposed IRB capital charges, partly because the net interest income from performing loans is not counted as a buffer against credit losses. A net interest income correction for IRB capital requirements is proposed.

This paper characterizes the optimal securities for venture capital finance in an environment with multiple investment stages and double-sided moral hazard in the relationship between entrepreneurs and venture capitalists. We show that if the conditions relevant for continuation into later stages are verifiable, the optimal security gives the venture capitalist a constant share in the success return of the project over a predetermined set of continuation states. Otherwise, the parties sign an initial start-up contract that is later renegotiated. In this case, in order to minimize the incentive distortions associated with the burden of early financing stages, the optimal start-up security gives a zero payoff in low profitability states and thereafter an increasing share in the success return of the project.