Abstract

http://ssrn.com/abstract=1786637
 
 

References (49)



 
 

Citations (25)



 


 



Caught between Scylla and Charybdis? Regulating Bank Leverage When There is Rent Seeking and Risk Shifting


Hamid Mehran


Federal Reserve Bank of New York

Viral V. Acharya


New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Anjan V. Thakor


Washington University, Saint Louis - John M. Olin School of Business; European Corporate Governance Institute (ECGI)

February 2013

ECGI - Finance Working Paper No. 365/2013
AFA 2012 Chicago Meetings Paper

Abstract:     
Banks face two moral hazard problems: asset substitution by shareholders (e.g., making risky, negative net present value loans) and managerial rent seeking (e.g., investing in inefficient “pet” projects or simply being lazy and un-innovative). The privately-optimal level of bank leverage is neither too low nor too high: It balances efficiently the market discipline imposed by owners of risky debt on managerial rent-seeking against the asset-substitution induced at high levels of leverage. However, when correlated bank failures can impose significant social costs, regulators may bail out bank creditors. Anticipation of this generates an equilibrium featuring systemic risk in which all banks choose inefficiently high leverage to fund correlated assets. A minimum equity capital requirement can rule out asset substitution but also compromises market discipline by making bank debt too safe. The optimal capital regulation requires that a part of bank capital be unavailable to creditors upon failure, and be available to shareholders only contingent on good performance.

Number of Pages in PDF File: 53

Keywords: Market Discipline, Asset Substitution, Systemic Risk, Dailout, Forbearance, Moral Hazard, Capital Requirements

JEL Classification: G21, G28, G32, G35, G38

Accepted Paper Series





Download This Paper

Date posted: March 15, 2011 ; Last revised: June 27, 2013

Suggested Citation

Mehran, Hamid and Acharya, Viral V. and Thakor, Anjan V., Caught between Scylla and Charybdis? Regulating Bank Leverage When There is Rent Seeking and Risk Shifting (February 2013). ECGI - Finance Working Paper No. 365/2013; AFA 2012 Chicago Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1786637 or http://dx.doi.org/10.2139/ssrn.1786637

Contact Information

Hamid Mehran (Contact Author)
Federal Reserve Bank of New York ( email )
33 Liberty Street
New York, NY 10045
United States
212-720-6215 (Phone)
Viral V. Acharya
New York University - Leonard N. Stern School of Business ( email )
44 West 4th Street
New York, NY NY 10012
United States
HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
New York University (NYU) - Department of Finance
Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
Anjan V. Thakor
Washington University, Saint Louis - John M. Olin School of Business ( email )
One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
European Corporate Governance Institute (ECGI) ( email )
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Feedback to SSRN


Paper statistics
Abstract Views: 1,495
Downloads: 268
Download Rank: 44,429
References:  49
Citations:  25

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo2 in 0.344 seconds