Ethics, Capital and Talent Competition in Banking

51 Pages Posted: 28 Mar 2019 Last revised: 22 Feb 2022

See all articles by Fenghua Song

Fenghua Song

Pennsylvania State University - Smeal College of Business

Anjan V. Thakor

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

Date Written: December 30, 2021

Abstract

We model optimal ethical standards, capital requirements and talent allocation in banking. Banks with varying safety-net protections, including depositories and shadow banks, innovate products and compete for talent. Managers dislike unethical behavior, but banks heed it only because detection imposes costs. We find: (i) higher capital induces higher ethical standards, but socially optimal capital requirements may tolerate some unethical behavior; (ii) managerial ethics fails to raise banks' ethical standards; (iii) banks with lower ethical standards attract better talent and innovate more; and (iv) it is socially optimal to allocate better talent to shadow banks instead of depositories, and this allocation results in higher capital requirements and ethical standards for depositories. Consequently, with capital capacity constraints, the shadow banking sector is larger than the depository sector; talent competition induces a race to the bottom in ethical standards, and the regulator responds by setting capital requirements to magnify this size difference.

Keywords: Ethics, Bank capital, Talent, Financial innovation

JEL Classification: D18, G20, G28

Suggested Citation

Song, Fenghua and Thakor, Anjan V., Ethics, Capital and Talent Competition in Banking (December 30, 2021). Journal of Financial Intermediation, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3347492 or http://dx.doi.org/10.2139/ssrn.3347492

Fenghua Song (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States
814.863.4905 (Phone)

HOME PAGE: http://sites.google.com/site/fenghua8song/

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 the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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