Ethics, capital and talent competition in banking

Fenghua Song and Anjan Thakor

Journal of Financial Intermediation, 2022, vol. 52, issue C

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 (search for similar items in EconPapers)
JEL-codes: D18 G20 G28 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinin:v:52:y:2022:i:c:s104295732200016x

DOI: 10.1016/j.jfi.2022.100963

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