Allocating Bank Regulatory Powers: Lender of Last Resort, Deposit Insurance and Supervision

46 Pages Posted: 13 Dec 2005  

Charles M. Kahn

University of Illinois, Urbana-Champaign; Feseral Reserve Bank of Saint Louis; Bank of Canada

João A. C. Santos

Federal Reserve Bank of New York

Multiple version iconThere are 2 versions of this paper

Date Written: May 2004

Abstract

Bank regulation in most countries encompasses a lender of last resort, deposit insurance and supervision. These functions are interrelated and therefore require coordination among the authorities responsible for them. These authorities, however, are often established with different mandates, some of which are likely to be in conflict. We consider these issues by studying the optimal institutional allocation of such functions.

We find that a single regulator will lead to insufficient bank monitoring and suboptimal bank investment in loans. It may also lead to too much forbearance. We consider alternative structures to deal with the problem of excess forbearance both in a full information setting and in settings with asymmetry of information between regulators. We show in the former setting that if it is feasible to prespecify the rates on lending of last resort, then it is useful to make this function the exclusive province of one regulator. By giving the deposit insurer the authority to close banks and by having last resort lending insured, one gives the deposit insurer strong incentives against forbearance. If it is not possible to pre-specify such rates, then a useful arrangement is to have both the central bank and the deposit insurer acting as lenders of last resort. In this structure it is important for the last resort lending to be uninsured in order to reduce temptation to overlend, although this somewhat increases the deposit insurer's temptation to forbear.

The final section of the paper analyses asymmetry of information between regulators. We show that regulators may have an incentive not to share gathered information. Since some regulators find it easier to collect particular information, this result suggests that it is important to consider informational advantages in the allocation of bank regulation.

JEL Classification: G21, G28

Suggested Citation

Kahn, Charles M. and Santos, João A. C., Allocating Bank Regulatory Powers: Lender of Last Resort, Deposit Insurance and Supervision (May 2004). AFA 2002 Atlanta Meetings; BIS Working Paper No. 102. Available at SSRN: https://ssrn.com/abstract=260589 or http://dx.doi.org/10.2139/ssrn.260589

Charles M. Kahn

University of Illinois, Urbana-Champaign ( email )

Department of Finance
340 Wohlers Hall
Champaign, IL 61820
United States

HOME PAGE: http://kahnfrance.com/cmk/

Feseral Reserve Bank of Saint Louis

411 Locust St
Saint Louis, MO 63011
United States

Bank of Canada

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

João A. C. Santos (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5583 (Phone)
212-720-8363 (Fax)

HOME PAGE: HTTP://WWW.NEWYORKFED.ORG/RMAGHOME/ECONOMIST/SANTOS/CONTACT.HTML

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