We examine the evolution of credit risk co-dependence in the banking sectors of over 65 countries. We find that there has been a significant increase in default risk co-dependence over the 3-year period leading up to the financial crisis. We also find that countries that are more integrated with liberalized financial systems have seen a greater rise in co-dependence in their banking sectors. This negative effect of financial openness is mitigated by a strong institutional environment that allows for efficient public and private monitoring of financial institutions.

The global financial crisis brought government guarantees to the forefront of the debate. Based on a review of frictions that hinder financial contracting, this paper concludes that the common justifications for government guarantees—i.e., principal-agent frictions or un-internalized externalities in an environment of risk neutrality—are flawed. Even where risk is purely idiosyncratic—and thus diversifiable in principle—government guarantees (typically granted via development banks/agencies) can be justified if private lenders are risk averse and because of the state's comparative advantage over markets in resolving the collective action frictions that hinder risk spreading. To exploit this advantage while keeping moral hazard in check, however, development banks/agencies have to price their guarantees fairly, crowd in the private sector, and reduce their excessive risk aversion. The latter requires overcoming agency frictions between managers and owner (the state), which would likely entail a significant reshaping of development banks’ mandates, governance, and risk management systems.

Using close to 800,000 transactions by 66,000 households in the United States and close to 2,000,000 transactions by 303,000 households in Finland, this paper shows that, on average, individual investors with longer holding periods choose to hold less liquid stocks in their portfolios. The relationship between holding periods and transaction costs is stronger among more financially sophisticated households. We confirm our findings by analyzing changes in investors’ holding periods around exogenous shocks to stock liquidity. Our findings challenge the notion that individual investors ignore non-salient costs when making investment decisions and suggest that they are cognizant of the cost of trading stocks.

This paper examines the relationship between banks’ capitalization strategies and their corporate governance and executive compensation schemes for an international sample of banks over the 2003–2011 period. Shareholder-friendly corporate governance, in the form of a separation of the CEO and chairman of the board roles, intermediate board size, and an absence of anti-takeover provisions, is associated with lower bank capitalization, consistent with shareholder incentives to shift risk towards the financial safety net. Higher values of executive option and stock wealth invested in the bank are associated with higher capitalization as a potential reflection of executive risk aversion, but the risk-taking incentives embedded in executive compensation packages are associated with lower capitalization.

We explore and summarize the evolution in bank capital regulations and bank risk after the global financial crisis. Using a new survey of bank regulation and supervision covering more than 120 economies, we show that regulatory capital increased, but some elements of capital regulations became laxer. Analyzing bank-level data, we also document the importance of defining bank regulatory capital narrowly as the quality of capital matters in reducing bank risk. This is particularly true for banks that have more discretion in the computation of regulatory capital ratios and are subject to weaker market monitoring.