Optimal Communication in Banking Supervision

50 Pages Posted: 12 Feb 2024 Last revised: 20 Mar 2024

See all articles by Jeong Ho (John) Kim

Jeong Ho (John) Kim

Florida State University - Department of Finance

Kyungmin Kim

Emory University

Victoria Liu

Federal Reserve Bank of Boston

Noam Tanner

Federal Reserve Bank of Boston

Date Written: March 13, 2024

Abstract

We present a model of banking supervision in which the supervisor first communicates her information to a privately informed bank and later decides whether to approve or disapprove the bank's investments. The supervisor's optimal communication strategy features ``muddling'' to introduce uncertainty into the bank's problem, thereby inducing the bank to act on its own signal. We demonstrate that the quality of supervision can deteriorate as the bank becomes more informed; in particular, the supervisor cannot utilize the bank's information when it is almost perfect. We propose a few ways to mitigate this problem within our framework.

Keywords: Banking Supervision, Communication Game, Information Design, Supervisory Guidance, Stress Tests

JEL Classification: D82, D83, G21, G28

Suggested Citation

Kim, Jeong Ho and Kim, Kyungmin and Liu, Victoria and Tanner, Noam, Optimal Communication in Banking Supervision (March 13, 2024). Available at SSRN: https://ssrn.com/abstract=4694813 or http://dx.doi.org/10.2139/ssrn.4694813

Jeong Ho Kim (Contact Author)

Florida State University - Department of Finance ( email )

Tallahassee, FL 32306-1042
United States

Kyungmin Kim

Emory University ( email )

201 Dowman Drive
Atlanta, GA 30322
United States

HOME PAGE: http://https://sites.google.com/site/kyungminteddykim/Home

Victoria Liu

Federal Reserve Bank of Boston

Noam Tanner

Federal Reserve Bank of Boston

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