Trust: The Social Virtues and the Creation of Prosperity

Anarchy, state, and utopia

After virtue, a study in moral theory

How the mind works

The morality of freedom

The current crisis and its high social cost have shattered the confidence of economic agents in the banking system and questioned the capacity of financial markets to channel resources to their best use. While it is essential for the well functioning of economic activity that financial institutions do take risk, the decisions taken by financial intermediaries have proven ex post to be excessively risky. So, what was wrong with financial regulation? How were overoptimistic expectations, short termism and inaccurate risk models implicitly encouraged? This book is devoted to exploring the general issue of the origins of excessive risk-taking in the banking industry. In doing so, it will provide the analytical ammunition required to rigorously examine regulatory policy at a time when it is undergoing a complete metamorphosis.

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Corporate Governance and Banks: What Have We Learned From the Financial Crisis?

The credit derivatives market provides a liquid but opaque forum for secondary market trading of banking assets I show that, when entrepreneurs rely on the certification value of bank debt to obtain cheap bond market finance, the existence of a credit derivatives market may cause them to issue sub-investment grade bonds instead and engage in second-best behavior Credit derivatives can therefore cause disintermediation and thus reduce welfare I argue that this effect can be most effectively countered by the introduction of reporting requirements for credit derivatives

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Credit Derivatives, Disintermediation and Investment Decisions

We investigate the optimal regulation of financial conglomerates that combine a bank and a non-bank financial institution. The conglomerate's risk-taking incentives depend upon the level of market discipline it faces, which in turn is determined by the conglomerate's liability structure. We examine optimal capital requirements for standalone institutions, for integrated financial conglomerates, and for financial conglomerates that are structured as holding companies. For a given risk profile, integrated conglomerates have a lower probability of failure than either their standalone or decentralized equivalent. However, when risk profiles are endogenously selected conglomeration may extend the reach of the deposit insurance safety net and hence provide incentives for increased risk-taking. As a result, integrated conglomerates may optimally attract higher capital requirements. In contrast, decentralized conglomerates are able to hold assets in the socially most efficient place. Their optimal capital requirements encourage this. Hence, the practice of 'regulatory arbitrage', or of transferring assets from one balance sheet to another, is welfare-increasing. We discuss the policy implications of our finding in the context not only of the present debate on the regulation of financial conglomerates but also in the light of existing US bank holding company regulation.

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Regulating Financial Conglomerates

We analyse a general equilibrium model in which there is both adverse selection of and moral hazard by banks. The regulator has several tools at their disposal to combat these problems. They can audit banks to learn their type prior to giving them a license, they can audit them ex post to learn the success probability of their projects and can impose capital adequacy requirements. When the regulator has a strong reputation for ex ante auditing, they use capital requirements to combat moral hazard problems. For less competent regulators, capital requirements can substitute for ex ante auditing ability. In this case, the banking system exhibits multiple equilibria so that crises of confidence in the banking system can occur only when the regulator's reputation is poor. Contrary to conventional wisdom, depending on regulator reputation, the appropriate policy response to a crisis of confidence may be to tighten capital requirements to improve the quality of surviving banks.

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Crises and Capital Requirements in Banking

We analyze a general equilibrium model in which there is both adverse selection of, and moral hazard by, banks. The regulator can screen banks prior to giving them a licence, audit them ex post to learn the success probability of their projects, and impose capital adequacy requirements. Capital requirements combat moral hazard when the regulator has a strong screening reputation, and they otherwise substitute for screening ability. Crises of confidence can occur only in the latter case, and contrary to conventional wisdom, the appropriate policy response may be to tighten capital requirements to improve the quality of surviving banks.

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Alan D. Morrison

Papers

Corporate Governance and Banks: What Have We Learned From the Financial Crisis?

Credit Derivatives, Disintermediation and Investment Decisions

Regulating Financial Conglomerates

Crises and Capital Requirements in Banking

Crises and Capital Requirements in Banking