Posted: 26 Aug 2005
We examine the optimal institutional allocation of bank regulation. We find that centralizing the lending of last resort and deposit insurance functions in a regulator leads to excessive forbearance. It also leads the bank to invest suboptimaly in loans. Giving this regulator supervision improves on both problems, but it still does not lead to the efficient outcome. In the multi-regulator arrangement, we find that it is beneficial to give supervision to the deposit insurer. The choice between the unified-regulator arrangement and the multi-regulator arrangement involves a trade-off: The multi-regulator arrangement reduces the forbearance problem at high levels of liquidity shortage but may exacerbate it at low levels. These results assume the absence of information frictions. When banks are better informed than regulators, we show that regulators may have an incentive notto share private information, suggesting it is important to consider regulators' informational advantages when deciding on the allocation of regulation.
JEL Classification: G21, G28
Suggested Citation: Suggested Citation
Kahn, Charles M. and Santos, João A. C., Allocating Bank Regulatory Powers: Lender of Last Resort, Deposit Insurance and Supervision. European Economic Review, Vol. 49, No. 8, pp. 2107-2136, 2005. Available at SSRN: https://ssrn.com/abstract=784647 or http://dx.doi.org/10.2139/ssrn.260589