The principal–agent problem between the regulator, regulated banks, and taxpayers is critical to the viability of the financial system’s safety net. There exists the danger that the regulator will collude with regulated banks to pursue their benefits at the expense of taxpayers, thereby reducing effectiveness of financial supervision. This paper proposes that the human relationship prevailing between the regulatory authorities and private banks referred to as “amakudari” is a form of collusion between the regulator and banks that endangers the safety net mechanism in Japan. Statistical analysis of data on regional banks shows that those banks accepting post-retirement officials from the Ministry of Finance have reduced capital adequacy levels and increased non-performing loans. Thus, the statistical result supports the hypothesis proposed in this paper

This paper studies moral hazard in banking due to delegated monitoring in an environment of aggregate risk and examines its implications for credit market equilibrium and regulation, in a model where banks are price competitors for loans and deposits. It provides a rationale for an incentive-based lending capacity positively linked to the bank's capital and profit margin, for an oligopolistic market structure wherever banks have market power, and for capital requirements. Social-welfare-maximizing capital requirements are lowered in recessions, are higher the more fragmented the banking sector, and are increased when anti-competitive measures are removed. In equilibrium banks earn excessive profits and credit may be rationed. Journal of Economic Literature Classification Numbers: D82, G28, L13

In recent years, regulators have increased their focus on the capital adequacy of banking institutions to enhance the stability of the financial system. The purpose of the present paper is to shed some light on whether and how Swiss Banks react to constraints placed by the regulator on their capital. Building on previous work by Shrieves and Dahl (cf. Shrieves, R.E., Dahl, D., 1992. The relationship between risk and capital in commercial banks. Journal of Banking and Finance 16, 439–457), we use a simultaneous equations model to analyse adjustments in capital and risk at Swiss banks, when those approach the minimum regulatory capital level. Our results indicate that regulatory pressure induce banks to increase their capital, but does not affect the level of risk

Moody's endorses the Basel Committee's proposal to use banks' internal risk assessments to refine the Basel Accord's risk weights on bank assets and commitments. External risk assessments, such as Moody's credit ratings, will likely play a supporting role as direct inputs into banks' internal rating systems and as tools for benchmarking and validating those systems. However, the widespread use of ratings in regulation threatens to undermine the quality of credit over time by increasing rating shopping, decreasing rating agency independence, and reducing incentives to innovate and improve the quality of ratings. This paper discusses how bank regulators can use external ratings in ways that mitigate the adverse incentives created by the resulting regulatory demand for rating agency services

This paper develops a framework for analyzing tradeoffs between policies for cleaning banks' balance sheets of bad debt when asymmetric information exists between banks and regulators regarding the amount of bad debt. The framework consists of a two-tier hierarchy composed of a regulator, banks, and firms. Hidden information and moral hazard are present at each tier of the hierarchy. The analysis identifies two types of effects of the regulator's policy choice: a direct effect on a bank's willingness to reveal its bad loans versus hiding them via loan rollovers, and an indirect effect on firm behavior as a function of the bank's response. The framework is applied to analyze tradeoffs between three policies: a laissez-faire policy, transfer of debt to an asset management company, and cancellation of debt inherited from a previous regime. Journal of Economic Literature Classification Numbers: G21; G28; G30; P34

This paper explores how to incorporate banks' capital structure and risk-taking into models of production. In doing so, the paper bridges the gulf between (1) the banking literature that studies moral hazard effects of bank regulation without considering the underlying microeconomics of production and (2) the literature that uses dual profit and cost functions to study the microeconomics of bank production without explicitly considering how banks' production decisions influence their riskiness. Various production models that differ in how they account for capital structure and in the objectives they impute to bank managers – cost minimization versus value maximization – are estimated using U.S. data on highest-level bank holding companies. Modeling the bank's objective as value maximization conveniently incorporates both market-priced risk and expected cash flow into managers' ranking and choice of production plans. Estimated scale economies are found to depend critically on how banks' capital structure and risk-taking are modeled. In particular, when equity capital, in addition to debt, is included in the production model and cost is computed from the value-maximizing expansion path rather than the cost-minimizing path, banks are found to have large scale economies that increase with size. Moreover, better diversification is associated with larger scale economies while increased risk-taking and inefficient risk-taking are associated with smaller scale economies

One of the requirements of the Federal Deposit Insurance Corporation Improvement Act (FDICIA) was that bank regulators establish capital ratio zones that mandate prompt corrective action (PCA) and early intervention in troubled banks. However, prior research suggests that increases in regulatory capital standards can lead to offsetting increases in risk. This paper develops and estimates a 3SLS model to examine the simultaneous impact of PCA on both bank capital and credit risk. The results document that the FDICIA was effective in that, subsequent to its passage, US banks increased their capital ratios without offsetting increases in credit risk

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

The banking industry realizes that a vital and profitable segment of its clientele demands a significant online presence that complements the traditional “bricks and mortar” presence. A virtual minefield of traditional and new issues and risks arises as banks adopt 24/7 transactional websites in their pursuit of a “clicks and bricks” strategy. Banks face operational, security, legal, and reputation risk with their foray into online banking. An innovative and proactive approach to risk management is essential as banks move into this new territory. Recent regulatory and legislative developments suggest that as electronic banking evolves, the earlier regulatory stance of “self-regulation” appears to be changing to one of increased scrutiny

This study examines the impact of regulatory capital and several of its determinants (i.e., earnings, loan loss provisions, charge-offs and growth) on bank managers' financing decisions and investors' interpretations of those decisions. The analysis is related to two streams of research. We add to the corporate finance literature that seeks to explain the market's reaction to security issuances by developing and testing a refined set of predictions of the demand for debt and equity capital using a sample of capital-regulated firms (banks). We extend the accounting literature that links regulatory capital-management decisions with bank performance by examining whether investors infer that performance. We find that bank managers' financing choices reflect their private information regarding the levels of regulatory capital, earnings, and charge-offs in the issuance year. We document a negative market reaction to capital-increasing issuances and a positive reaction to capital-decreasing issuances. A cross-sectional analysis of that market reaction indicates that investors infer managers' expectations of earnings in the issuance year