This paper investigates how the regulation of bank wealth management products (WMPs) affects corporate innovation. We build a concise model linking firms’ assets allocation decisions to regulatory variables affecting banks. The model suggests that current WMP regulation can enhance formal lending and stimulate innovation among state-owned enterprises (SOEs), while having no impact on innovation in private enterprises (PEs). Empirically, we identify firms’ exposure to bank regulation by examining the number of WMPs issued by banks in 2017 and the distance between banks and firms. Our results indicate that innovation output significantly increased for highly exposed SOEs, while there was no significant change for PEs. Using city-level data, we further observe that regulation fosters innovation in regions with higher exposure. Our findings suggest that regulation exerts heterogeneous effects on the real economy by banks’ credit allocation and firms’ investment strategies

This paper is based on a panel discussion at the international bank conference on Frontier Risks, Financial Innovation and Prudential Regulation of Banks in Gothenburg, Sweden, June 2–4, 2024. The panelists were Deborah Lucas, Jan Pieter Krahnen, and Magnus Olsson, with Ted Lindblom moderating. This paper contains the panel presentations, along with a unifying discussion by Paolo Fulghieri and Anjan Thakor. The main themes in the paper focus on how society should balance costs and benefits in designing the prudential regulation of banks. Optimal regulation should take into account how banks and markets interact, the dangers of both under-regulation that spawns excessive risk-taking and over-regulation that depresses value-enhancing innovation in financial services, the somewhat fragmented nature of national-sovereignty-constrained European banking and financial markets regulation relative to bank regulation in the US, and how prudential regulation can be improved by more explicitly dealing with interest rate risk

This paper studies the impact of the loan-to-deposit (LTD) ratio regulation – a specific macroprudential policy instrument introduced in Korea – on bank-level lending supply and the subsequent firm-level real consequences. The bank-firm-level matched loan data reveals that small and medium enterprises (SMEs) were particularly hit by adverse lending supply shocks from banks with higher pre-regulation LTD ratios. However, they were compensated by new loans extended by banks with lower pre-regulation LTD ratios as well as unregulated non-bank financial institutions (NBFIs). After all, the regulation did not result in adverse consequences on firm-level net credit or real performance, possibly at the cost of rising corporate loans extended by the shadow banking system

This article studies the optimal design of bank capital regulations when capital markets are subject to adverse selection. I show how the implementation of capital requirements can eliminate the information frictions that make raising capital costly by screening banks to reveal their private information to the market. The optimal regulations induce information revelation via recapitalization programs when the banking sector is weak and pool the banks’ private information via uniform capital requirements otherwise. Optimal capital requirements are linked to the securities issued to meet them, demonstrating potential welfare gains from incorporating more and less informationally sensitive securities into the design of capital regulations. Finally, the analysis generates insights into the joint design of equity capital requirements and additional tier 1 capital securities

We show that widely used macroprudential regulations that rely on historical cost accounting (HCA) to insulate banks’ balance sheets from financial market volatility significantly affect the transmission of monetary policy onto bank lending. Using detailed supervisory data from Italian banks, we find that HCA mutes the transmission of quantitative easing and other monetary policies that affect the long end of the yield curve, weakening the effectiveness of interventions aimed at reducing firm credit constraints. We suggest alternative policies that have the benefits of HCA but allow monetary policy to pass through

We study capital regulation in a dynamic model for bank deposits. Capital regulation addresses banks’ incentive for excessive leverage that dilutes depositors, but preserves some dilution to reduce bank defaults. We show theoretically that capital regulation is subject to a time inconsistency problem. In a model with non-maturing deposits where optimal withdrawals make deposits endogenously long-term, we find commitment to have important effects on the optimal level and cyclicality of capital adequacy. Our results call for a systematic framework that limits capital regulators’ discretion

This paper argues that bonus caps can be welfare improving in banking labour markets with high mobility. On the labour market, the largest banks hire the most talented traders, but they need to do so with contracts with high bonuses in order to both screen talent and to prevent poaching by smaller banks. This can lead to excessive risk taking. In some cases, it is socially optimal to prevent screening, leading to a less efficient matching of talent to banks, but also to less risk taking. Bonus caps can achieve this in a way that is both more effective and less costly than setting tighter capital constraints

Bank bailouts are not “one-shot” events, as often portrayed, but rather dynamic processes with phases over time. Regulators “catch” financially distressed banks and provide aid, “restrict” these banks’ activities for ex ante unknown lengths of time, and then “release” the banks from the restrictions when capital ratios reach sufficiently healthy levels. This catch-restrict-release bailout approach is employed globally and applies to both major bailout methods capital injections (CIs) and debt guarantees (DGs). We model how a regulator that maximizes a social welfare function that includes the value of the bank and expected costs to the rest of the financial system and the real economy of its default might design and implement catch-restrict-release and test model predictions. Our data laboratory includes multiple EU nations over the financially stressful 2008-2014 period when many bailouts occurred. Findings suggest regulators bail out banks in a qualitatively consistent fashion with maximizing the social welfare function, yielding policy implications and directions for future research

We shed light on the narrative that listing contributes to risk-taking by examining the risk characteristics of listed BHCs, small enough to be private, against a sample of comparable private BHCs, large enough to be listed, over the 1987–2019 period. We measure our proxies for risk characteristics over different intervals in the sample period to account for the effect of new regulations and variation in the intensity of information production by regulators, markets, and financial firms. We document that listed banks are riskier than private banks over the 22-year sample period. Examining the subperiods, we find that listed banks are riskier than private banks before the crisis, but they may not be as risky following the crisis. While risk increases for all banks during the crisis, the increase in risk for listed banks during the crisis is greater than that for private banks. Our findings are both statistically and economically significant and suggest that financial reforms and regulatory expectations facing banks post-crisis might have contributed to the risk reduction for listed banks relative to private banks

Banks use trading as a vehicle to take risk. Using high-frequency regulatory data, we estimate the sensitivity of weekly bank trading profits to aggregate equity, fixed-income, credit, currency, and commodity risk factors. Our estimates imply that U.S. banks had large trading exposures to equity market risk before the Volcker Rule, which they curtailed afterwards. Credit and currency risk exposures were smaller. The results hold up in a quasi-natural experiment that exploits the phased-in introduction of reporting requirements for identification. Total trading-book risk was also curtailed afterwards with material financial stability implications and no evidence of migration to other bank activities