Bank Leverage and Social Welfare

Lawrence Christiano and Daisuke Ikeda

American Economic Review, 2016, vol. 106, issue 5, 560-64

Abstract: We describe a general equilibrium model in which an agency problem arises because bankers must exert an unobserved and costly effort to perform their task. Suppose aggregate banker net worth is too low to insulate creditors from bad outcomes on their balance sheet. Then, banks borrow too much in equilibrium because there is a pecuniary externality associated with bank borrowing. Social welfare is increased by imposing a binding leverage restriction on banks. We formalize this argument and provide a numerical example.

JEL-codes: G21 G28 G32 G38 (search for similar items in EconPapers)
Date: 2016
Note: DOI: 10.1257/aer.p20161090
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Citations: View citations in EconPapers (17)

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