Financial Development and the Opacity of Banks
7 Pages Posted: 14 Apr 2008
A puzzle posed by the subprime crisis is that even though financial development has made traditional bank assets less opaque, the opacity of banks themselves seems to have increased. This paper offers an explanation. I show that financial development which reduces the opacity of bank assets can have unwelcome effects by causing banks to move into less transparent and less efficient activities. The reason is that opacity is valued by bank managers as it makes it more difficult to discipline them. Following financial development, bank managers therefore substitute existing assets with less transparent activities, even though these have lower profitability.
Keywords: financial development, subprime, opaque assets, asset substitution
JEL Classification: G21, G28, G32
Suggested Citation: Suggested Citation