This paper investigates a firm's choice between borrowing from a single bank and from two banks. The focus is on how this decision affects banks' equilibrium monitoring intensities and loan rates. Two-bank lending suffers from duplication of effort and sharing of monitoring benefits, but it benefits from diseconomies of scale in monitoring. Thus, two-bank lending involves lower monitoring but not necessarily higher loan rates than single-bank lending. The optimal borrowing structure balances the benefit of monitoring for the firm in terms of higher success probability of the project against its drawbacks of lower expected private return and higher total monitoring costs. In contrast to the previous theoretical literature, the model lays down an explanation for the empirical observation that multiple-bank lending does not unambiguously increase loan rates or firms' quality, in particular in small business lending.

Elena Carletti of Bocconi University reviews “Unexpected Revolutionaries: How Central Banks Made and Unmade Economic Orthodoxy” by Manuela Moschella. The Econlit abstract of this book begins: “Explores the development of central banks from the heyday of monetary orthodoxy in the 1980s to the 2008 global financial crisis and the 2020 COVID-19 crisis, explaining why central banks responded to changed economic conditions by breaking with monetary orthodoxy and what consequences this evolutionary path entails for the role of central banks in domestic societies.”

We develop a model where banks invest in reserves and loans, and trade loans on the interbank market to deal with liquidity shocks. Two types of equilibria emerge, depending on the degree of credit market competition and the level of aggregate liquidity risk. In one equilibrium, all banks keep enough reserves and remain solvent. In the other, some banks default with positive probability. The latter equilibrium exists when competition is weak and large liquidity shocks are unlikely. The model delivers several implications concerning the relationship between competition, aggregate credit, and welfare.

Loan guarantees represent a form of government intervention to support bank lending. However, their use raises concerns as to their effect on bank risk-taking incentives. In a model of financial fragility that incorporates bank capital and a bank incentive problem, we show that loan guarantees reduce depositor runs and improve bank underwriting standards, except for the most poorly capitalized banks. We highlight a novel feedback effect between banks’ underwriting choices and depositors’ run decisions, and show that the effect of loan guarantees on banks’ incentives is different from that of other types of guarantees, such as deposit insurance.

[Empirical evidence suggests that banks hold capital in excess of regulatory minimums. This did not prevent the financial crisis and underlines the importance of understanding bank capital determination. Market discipline is one of the forces that induces banks to hold positive capital. The literature has focused on the liability side. We develop a simple theory based on monitoring to show that discipline from the asset side can also be important. In perfectly competitive markets, banks can find it optimal to use costly capital rather than the interest rate on the loan to commit to monitoring because it allows higher borrower surplus.]

Before 2007, financial crises were not widely studied in economics and finance. The lack of importance ascribed to financial stability and our limited knowledge of this topic were significant contributors to the crisis. This paper suggests five areas where new theories are needed. These are asset price bubbles, central bank checks and balances, global imbalances, banking regulation, and competition in financial services.

When liquidity plays an important role as in financial crises, asset prices may reflect the amount of liquidity available rather than the asset's future earning power. Using market prices to assess financial institutions’ solvency in such circumstances is not desirable. We show that a shock in the insurance sector can cause the current market value of banks’ assets to fall below their liabilities so they are insolvent. In contrast, if values based on historic cost are used, banks can continue and meet all their future liabilities. We discuss the implications for the debate on mark-to-market versus historic cost accounting.

This paper analyzes banks' choice between lending to firms individually and sharing lending with other banks, when firms and banks are subject to moral hazard and monitoring is essential. Multiple-bank lending is optimal whenever the benefit of greater diversification in terms of higher monitoring dominates the costs of free-riding and duplication of efforts. The model predicts a greater use of multiple-bank lending when banks are small relative to investment projects, firms are less profitable, and poor financial integration, regulation and inefficient judicial systems increase monitoring costs. These results are consistent with empirical observations concerning small business lending and loan syndication.

We analyze the strengths and weaknesses of stakeholder and shareholder firms in a model of imperfect competition. Stakeholder firms are more concerned with avoiding bankruptcy to protect their employees and suppliers. In equilibrium, they are more valuable than shareholder firms when marginal cost uncertainty exceeds demand uncertainty. With globalization shareholder firms and stakeholder firms often compete. We identify the circumstances where stakeholder firms are more valuable than shareholder firms and compare these mixed equilibria with the pure equilibria with stakeholder and shareholder firms only. Finally, we analyze firm financial constraints and derive implications for the capital structure of stakeholder firms.

We present a general equilibrium model of banks’ optimal capital structure where bankruptcy is costly and investors have heterogeneous endowments and incur a cost for participating in equity markets. We show that, besides its social benefits, capital regulation benefits bank shareholders when it resolves fire sales externalities but not when it acts as a tax on bank profits such as when used to control excessive leverage induced by deposit insurance. Furthermore, capital regulation widens the gap between the returns to bank shareholders and depositors and may reduce investments in projects in favor of storage.