Banks take costly actions (such as capitalization, liquidity holding, and advanced risk management) to avoid financial distress and creditor runs. While directly affecting a bank’s risks, such actions can also signal the bank’s fundamentals. We show that prudential regulations have an informational impact: sufficiently tight regulations can eliminate inefficient separating equilibria in banks’ signaling game, thereby changing the information available to creditors and their incentives to run. When accounting for this informational impact, tightening regulations can improve banks’ payoffs and be considered bank incentive-compatible. We support this novel, information-based rationale for regulations with evidence from the US liquidity requirement

Before regulations were enacted to prevent such practices, information leaked through selective disclosure was incorporated into markets prior to the public release of news. “News days” did not deliver news to markets; now they do. We provide novel evidence of changes in returns and turnover behavior around the enactment of regulations barring selective disclosure practices in the United States and the EU. We conversely document lack of such changes in Australia and Japan, which did not implement similar measures. We conclude that selective disclosure resolves Roll’s R2 puzzle

This paper theoretically and empirically investigates the effects of liquidity regulation on the banking system. We document that the current quantity-based liquidity rule has reduced banks' liquidity risks. However, the mandated liquidity buffer appears to crowd out bank lending and lead to a migration of liquidity risks to banks that are not subject to liquidity regulation. These findings motivate a model of liquidity regulation with endogenous liquidity premiums and heterogeneous banks. The model shows that the current liquidity rule can improve upon the unregulated equilibrium but can also have distortionary effects because of the dual role of the liquidity buffer as an implicit tax and a costly mitigator of liquidity risks. The fixed quantity mandate can interact with the uncertain liquidity demand, amplifying the volatility in the liquidity premium. A central bank committed liquidity facility could improve the current quantity-based regulation by introducing a price-based mechanism

This paper shows that mandating some firms to disclose more while leaving other firms disclosing voluntarily is less effective in improving and may even harm the overall information environment when firms' disclosures are endogenous. Although the regulated firms' increased disclosure directly reduces all firms' cost of capital, it crowds out the unregulated firms' voluntary disclosure and thus increases all firms’ cost of capital indirectly. Under certain circumstances, the negative indirect effect can outweigh the direct benefit. These results are consistent with the scant evidence on the cost-of-capital effect of mandatory disclosure. The model highlights the importance of the market-wide effects of disclosure regulation and facilitates quantitative cost-benefit analyses for specific regulatory proposals

This article studies the effects of higher bank capital requirements. Using new firm-lender matched credit data from South Korea, we document that Basel III coincided with a 25% decline in credit from regulated banks, and an increase of similar magnitude from non-bank (shadow) lenders. We use our data to estimate the effect of capital requirements on bank credit, and the spillover effect of the reform on non-bank lending. We then build a general equilibrium model with heterogeneous banks and firms that replicates these micro estimates. We find that Basel III can account for most of the observed decrease in regulated bank lending and about three quarters of the increase in shadow lending. The latter is driven exclusively by general equilibrium effects of the reform

The role of bank regulation and supervision (RS) on financial stability and welfare has been subject to ongoing research, especially since the Great Recession. RS is expected to help eliminate the adverse selection and moral hazard problems that are abundant in financial transactions. In this paper, we present a general equilibrium model that is augmented by either a bank regulatory and supervisory agent who chooses the level of RS by maximizing bank profits, or by a macroprudential agent who minimizes non-performing loans (NPL). We compare the long-term outcomes of these scenarios and show that minimizing NPL is feasible for a larger and economically more viable range of parameter values than the alternatives. Moreover, for a comparable set of parameter combinations, the optimal choice of RS that minimizes NPL leads to both higher levels of steady state income and lower interest spreads as compared to RS that maximizes bank profits

Caroline Fohlin of Emory University reviews “Taming the Street: The Old Guard, the New Deal, and FDR's Fight to Regulate American Capitalism” by Diana B. Henriques. The Econlit abstract of this book begins: “Explores Franklin Delano Roosevelt's development and enactment of the New Deal after the 1929 stock market crash and subsequent Great Depression, focusing on the establishment of the Securities and Exchange Commission (SEC

We conduct a lab experiment that shows that current rules regulating transplant centers (TCs) and organ-procurement organizations (OPOs) create perverse incentives that inefficiently reduce both organ recovery and beneficial transplantations. We model the decision environment with a two-player multiround game between an OPO and a TC. In the condition that simulates current rules, OPOs recover only the highest-quality kidneys and forgo valuable recovery opportunities, and TCs decline some beneficial transplants. Alternative regulations that reward TCs and OPOs together for health outcomes in their entire patient pool lead to behaviors that increase organ recovery and appropriate transplants

We study the capital market effects of information centralization by exploiting the staggered implementation of digital storage and access platforms for regulated financial information (Officially Appointed Mechanisms, or OAMs) in the European Union. We find that the implementation of OAMs results in significant improvements in capital market liquidity, consistent with the notion that OAMs lower investors' processing costs. The findings are more pronounced when processing costs are high to begin with, that is, when firms (1) are small and receive low business press coverage and (2) have high levels of retail ownership. We then identify a mechanism through which centralization facilitates capital market effects: information spillovers. First, we find that liquidity improvements are larger when OAMs have features that easily allow investors to search for peer firm information. Second, liquidity improvements are larger for firms with a high share of industry peers operating on the same OAM and for firms with a high share of small, low‐coverage peers on that OAM. Third, around the annual report release dates of peer firms, focal‐firm liquidity improves and focal‐peer stock return synchronicity increases. Overall, our evidence suggests that, even in a modern information age, information centralization improves capital market liquidity and facilitates the acquisition and use of peer firm information

This study presents a model in which behavioral investors shape their current expectations based on statistical analysis of historical non-disclosure events. Investors may hold overly optimistic expectations following a non-disclosure event, thereby disrupting unraveling toward forthcoming disclosures. While a regulator can mandate disclosure, this protective intervention has its drawbacks. Overprotection prevents investors from learning from losses and leads to cycles of high compliance followed by high mispricing when innovations in transactions render current regulations ineffective. An unregulated market, on the other hand, tends toward high transparency over time. The model further explains negative market reactions to regulation, an association between price drift and transparency, reversals in market confidence, and that regulators should favor laissez-faire in times of investor pessimism. Further implications are explored for regulations that facilitate learning and prevent cycles