Abstract

http://ssrn.com/abstract=1786637
 
 

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


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

Hamid Mehran


Federal Reserve Bank of New York

Anjan V. Thakor


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

September 11, 2015

AFA 2012 Chicago Meetings Paper
European Corporate Governance Institute (ECGI) - Finance Working Paper No. 365/2013

Abstract:     
We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures, regulators bail out creditors. Anticipation of this generates multiple equilibria, including one with systemic risk in which banks use excessive leverage to fund correlated, inefficiently risky loans. Limiting leverage and resolving both moral hazards — insufficient loan monitoring and asset substitution — requires a novel two-tiered capital requirement, including a “special capital account” that is unavailable to creditors upon failure.

Number of Pages in PDF File: 54

Keywords: market discipline, asset substitution, systemic risk, bailout, forbearance, moral hazard, capital requirements

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


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Date posted: March 15, 2011 ; Last revised: October 9, 2015

Suggested Citation

Acharya, Viral V. and Mehran, Hamid and Thakor, Anjan V., Caught between Scylla and Charybdis? Regulating Bank Leverage When There is Rent Seeking and Risk Shifting (September 11, 2015). AFA 2012 Chicago Meetings Paper; European Corporate Governance Institute (ECGI) - Finance Working Paper No. 365/2013. Available at SSRN: http://ssrn.com/abstract=1786637 or http://dx.doi.org/10.2139/ssrn.1786637

Contact Information

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
Hamid Mehran
Federal Reserve Bank of New York ( email )
33 Liberty Street
New York, NY 10045
United States
212-720-6215 (Phone)
Anjan V. Thakor (Contact Author)
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
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