This paper conducts the first empirical assessment of theories concerning risk taking by banks, their ownership structures, and national bank regulations. We focus on conflicts between bank managers and owners over risk, and we show that bank risk taking varies positively with the comparative power of shareholders within the corporate governance structure of each bank. Moreover, we show that the relation between bank risk and capital regulations, deposit insurance policies, and restrictions on bank activities depends critically on each bank's ownership structure, such that the actual sign of the marginal effect of regulation on risk varies with ownership concentration. These findings show that the same regulation has different effects on bank risk taking depending on the bank's corporate governance structure

Systemic risk is modeled as the endogenously chosen correlation of returns on assets held by banks. The limited liability of banks and the presence of a negative externality of one bank’s failure on the health of other banks give rise to a systemic risk-shifting incentive where all banks undertake correlated investments, thereby increasing economy-wide aggregate risk. Regulatory mechanisms such as bank closure policy and capital adequacy requirements that are commonly based only on a bank’s own risk fail to mitigate aggregate risk-shifting incentives, and can, in fact, accentuate systemic risk. Prudential regulation is shown to operate at a collective level, regulating each bank as a function of both its joint (correlated) risk with other banks as well as its individual (bank-specific) risk

We examine the effects of regulations designed to address the potential conflict of interest that arises when sell-side analyst research is not independent of investment banking. We focus on two types of regulation: (1) internal barriers between equity research and investment banking that restrict communication; and (2) disclosure requirements relating to analyst compensation. We find that information barriers can increase research effort and improve report quality by limiting an investment bank's ability to distort its analyst's incentives. However, this type of regulation can also reduce information production and lower the quality of reports if an investment bank benefits directly from research activity. Disclosure requirements, on the other hand, unambiguously lead to more informative prices and a higher report quality relative to either information barriers or no regulation

Banks can make suboptimal liquidity choices and gamble for lender of last resort (LOLR) support. Endogenous bailout rents are driven by the need to preserve bankers' incentives under uncertain net worth. In equilibrium, banks can herd in risk management, choosing suboptimal liquidity when they expect others to do so. Optimal liquidity can be restored by quantitative requirements, but such regulation is costly. An LOLR policy incorporating bank capital information can reduce distorting rents and allow for a more efficient solution, but may only be possible in transparent economies

Assessing the risk of bank failures is the paramount concern of bank regulation. This paper argues that in order to assess the default risk of a bank, it is important to consider its financing decisions as an endogenous dynamic process. We provide a continuous-time model, where banks choose the deposit volume in order to trade off the benefits of earning deposit premiums against the costs that occur at future capital structure adjustments. The bank’s asset value may suffer from shocks and follows a jump-diffusion process. Our main finding is that the dynamic endogenous financing decision introduces an important self-regulation mechanism, where it is crucial to distinguish between the diffusion risk and the jump risk component

The increasing dependence of individuals on debt financing raises several welfare considerations that we analyze in this paper. We develop a dynamic, competitive model of relationship banking to determine how regulation influences borrowing and lending behavior, and analyze how it affects welfare in the market. We characterize the lending regimes that arise based on public policy, and evaluate the optimal choice by the government to induce particular lending practices to arise. Finally, we consider the effect that a credit reporting agency has on the market. In the paper, we highlight the new empirical implications that the model generates

Using aggregate balance sheet data from banks across the EU-25 over the period from 1997 to 2005 we provide empirical evidence that national banking market concentration has a negative impact on European banks’ financial soundness as measured by the Z-score technique while controlling for macroeconomic, bank-specific, regulatory, and institutional factors. Furthermore, our analysis reveals that Eastern European banking markets exhibiting a lower level of competitive pressure, fewer diversification opportunities and a higher fraction of government-owned banks are more prone to financial fragility whereas capital regulations have supported financial stability across the entire European Union

We analyze the desirability of level playing fields in international financial regulation. In general, level playing fields impose the standards of the weakest regulator upon the best-regulated economies. However, they may be desirable when capital is mobile because they counter a cherry-picking effect that lowers the size and efficiency of banks in weaker economies. Hence, while a laissez faire policy favors the better-regulated economy, level playing fields are good for weaker regulators. We show that multinational banking mitigates the cherry-picking effect, and reduces the damage that a level playing field causes in the better-regulated economy

We analyze the desirability of level playing fields in international financial regulation. In general, level playing fields impose the standards of the weakest regulator upon the best‐regulated economies. However, they may be desirable when capital is mobile because they counter a cherry‐picking effect that lowers the size and efficiency of banks in weaker economies. Hence, while a laissez faire policy favors the better‐regulated economy, level playing fields are good for weaker regulators. We show that multinational banking mitigates the cherry‐picking effect, and reduces the damage that a level playing field causes in the better‐regulated economy

This paper presents a model of the portfolio and financing adjustments of U.S. banks over the business cycle. At the core of the model is a moral hazard problem between depositors/bank regulators and stockholders. The solution to this problem takes the form of shared management of the bank. Stockholders manage the bank's portfolio and the regulator manages the financing of the portfolio. The model predicts that portfolio adjustments are made to conform to the risk aversion of shareholders and financing adjustments are made to offset changes in portfolio risk. Regression evidence for 1955–2000 fails to reject these predictions