In a dynamic model of moral hazard, competition can undermine prudent bank behavior. While capital-requirement regulation can induce prudent behavior, the policy yields Pareto-inefficient outcomes. Capital requirements reduce gambling incentives by putting bank equity at risk. However, they also have a perverse effect of harming banks' franchise values, thus encouraging gambling. Pareto-efficient outcomes can be achieved by adding deposit-rate controls as a regulatory instrument, since they facilitate prudent investment by increasing franchise values. Even if deposit-rate ceilings are not binding on the equilibrium path, they may be useful in deterring gambling off the equilibrium path

We analyze a general equilibrium model in which there is both adverse selection of, and moral hazard by, banks. The regulator can screen banks prior to giving them a licence, audit them ex post to learn the success probability of their projects, and impose capital adequacy requirements. Capital requirements combat moral hazard when the regulator has a strong screening reputation, and they otherwise substitute for screening ability. Crises of confidence can occur only in the latter case, and contrary to conventional wisdom, the appropriate policy response may be to tighten capital requirements to improve the quality of surviving banks

Until the middle of the 1970's, regulations constrained banks' ability to enter new markets. Over the subsequent 25 years, states gradually lifted these restrictions. This paper tests whether rents fostered by regulation were shared with labor, and whether firms were discriminating by sharing these rents disproportionately with male workers. We find that average compensation and average wages for banking employees fell after states deregulated. Male wages fell by about 12 percent after deregulation, whereas women's wages fell by only 3 percent, suggesting that rents were shared mainly with men. Women's share of employment in managerial positions also increased following deregulation

We develop a structural empirical model of the US banking sector. Insured depositors and run-prone uninsured depositors choose between differentiated banks. Banks compete for deposits and endogenously default. The estimated demand for uninsured deposits declines with banks' financial distress, which is not the case for insured deposits. We calibrate the supply side of the model. The calibrated model possesses multiple equilibria with bank-run features, suggesting that banks can be very fragile. We use our model to analyze proposed bank regulations. For example, our results suggest that a capital requirement below 18 percent can lead to significant instability in the banking system

The pattern of disagreement between bond raters suggests that banks and insurance firms are inherently more opaque than other types of firms. Moody's and S&P split more often over these financial intermediaries, and the splits are more lopsided, as theory here predicts. Uncertainty over the banks stems from certain assets, loans and trading assets in particular, the risks of which are hard to observe or easy to change. Banks' high leverage, which invites agency problems, compounds the uncertainty over their assets. These findings bear on both the existence and reform of bank regulation

Central bank money is the foundation of modern monetary and payment systems. Central bank money defines a unit of account; the price at which this money trades determines “monetary policy”; and most payment systems require the transfer of central bank funds before a transaction is legally final, or “settled.” Despite its current ubiquity, the origins of central bank money have remained obscure, and the present-day system involves a remarkable conceptual leap from earlier coin-based systems. In this paper we recount how the critical innovation—the creation of a unit of account that could be maintained solely through open market operations—took place in the seventeenth-century Dutch Republic (for a more detailed examination see Stephen Quinn and William Roberds 2005, Quinn and Roberds 2006). The villain in our story is the incremental debasement that unsettled the quality of new coins and price of old coins. The protagonists are the Dutch authorities who contended with debasement by regulating the price of coins and by creating “exchange banks, ” the Bank of Amsterdam in particular, to assure the quality of coins. The plot is propelled forward because well-intentioned regulatory changes exacerbated the debasement

This essay assesses whether network linkages within the banking system amplified the real effects of bank failures during the Great Contraction. In 1929, nearly all interbank deposits held by Federal Reserve member banks belonged to “shadowy” nonmember banks which were outside the regulatory reach of federal regulators. Regional banking panics in the early 1930s drained these interbank deposits from central reserve city banks. Money-center banks in Chicago and New York responded to volatile and declining interbank deposits by changing their asset composition. They reduced their lending to businesses and individuals, and increased their holdings of cash and government bonds

A fixed-rate deposit insurance system provides a moral hazard for excessive risk taking and is not viable absent regulation. Although the deposit insurance system appears to have worked remarkably well over most of its 50-year history, major problems began to appear in the early 1980's. This paper tests the hypothesis that increases in competition caused bank charter values to decline, which in turn caused banks to increase default risk through increases in asset risk and reductions in capital

If insuring creditors of commercial banks in the way they have been insured since mid-1933 is justified, then so is regulation of so-called insured banks, those with creditors insured by the Federal Deposit Insurance Corporation (FDIC). In creating the FDIC, the Congress mandated a pricing policy: all banks with FDIC-insured creditors were to be charged alike; more particularly, the FDIC was not to charge insured banks according to the riskiness of their respective balance sheets. Nor has it ever. Yet, with an insurance premium that is constant across balance sheets, there is an incentive for risk taking. And thus, unless insured banks are to be as risky as profit maximization dictates, they must, one way or another, be effectively regulated; they must, that is, be limited by regulation to appropriately risky balance sheets. It does not follow that U.S. bank regulatory policy of the years since 1933 is beyond criticism. For example, we must wonder about the geographical restrictions imposed under the McFadden Act and the Douglas Amendment to the Bank Holding Company Act. But it does follow that if banks with FDIC-insured creditors are to be made entirely free, except perhaps of reserve requirements, or even largely free, then it is necessary to either close up the FDIC or, if doing that seems unwise, change FDIC policy. There has already been some deregulation. Most importantly, Regulation Q has been made much less effective than it was; and evidently it has been marked to become, very soon, a thing of the past. So far, however, beyond deregulating, the Congress has not bestirred itself. The FDIC is still occupying its Washington corner. Although FDIC officials have hinted at change, its policy is still by and large what it was. And the Congress, being ever so respectful of the consumer lobby, may never want to do anything. Nevertheless, in this paper I consider various things it might do: namely, close down the FDIC, but at the same time impose a new valuation rule for bank portfolios; change FDIC pricing policy; and, lastly, without doing anything else, simply close down the FDIC. I do not end up by saying what, as I believe, the Congress ought to do. My purpose is only to determine, as best I am able, which of those several apparent congressional options of mine are in reality feasible. I would add, however, that the Congress, if bent on deregulating banks or obliging the regulatory agencies, has more to do than decide what to do about the FDIC. It seems also to be bent on deregulating or allowing the deregulation of savings and loan associations. There has already been more deregulation of savings and loan associations than of banks. So the Congress has also to decide what to do about the Federal Savings and Loan Insurance Corporation (FSLIC). Fortunately, to explore what it might do about the FDIC is perforced to explore what it might do about the FSLIC

Neoclassical models of the banking firm (for example, Michael Klein, 1971) treat all deposit liabilities as fully variable factors of production. Banks then maximize profits (minimize liability costs) by equating the marginal costs of all liability types during each period. The empirical relevance of these models is difficult to establish because binding deposit rate ceilings (Regulation Q) force bank competition for many retail deposits into implicit interest channels that are not readily measured. It is therefore noteworthy that during two recent periods when deposit rate ceilings were not binding, banks paid retail deposit rates considerably in excess of the rate at which they could borrow via large, unregulated certificates of deposit. Such behavior seems inconsistent with the cost minimization prescribed by neoclassical bank models. However, if retail deposit accounts are interpreted as quasi fixed (Gary Becker, 1962; Walter Oi, 1962; Donald Parsons, 1972; Sherwin Rosen, 1968) inputs to the banking firm, these important historical observations can be reconciled with bank profit maximization. This paper first describes two historical episodes during which the bank retail deposit rate exceeded the negotiable certificate of deposit rate for substantial periods of time. While no profit-maximizing (cost-minimizing) bank would pay such a rate differential if retail deposit quantities are costlessly variable, interpreting retail deposit accounts as quasi-fixed inputs to the bank explains the peculiar rate structures. A simple two-period model of bank liability selection formalizes the analysis. I. Two Puzzling Historical Episodes