State-contingent bank regulation with unobserved actions and unobserved characteristics
Edward Prescott ()
No 04-02, Working Paper from Federal Reserve Bank of Richmond
This paper studies bank regulation in the presence of deposit insurance, where banks have private information on their own ability and their investment strategy. Banks choose the mean and variance of their portfolio return. Regulators wish to control banks' risk choice, even though all agents are risk neutral and there are no deadweight costs of bank failure, because high risk adversely affects banks' ex ante incentives along other dimensions. Regulatory tools studied are capital requirements and return-contingent fines. Regulators can seek to separate bank types by offering a menu of contracts. We use numerical methods to study the properties of the model with two different bank types. Without fines, capital requirements only have limited ability to separate bank types. When fines are added, separation is much easier. Fine schedules and capital requirements are tailored to bank type. Low quality banks are fined when they produce high returns in order to control risk-taking behavior. High quality banks face fines on lower returns to prevent low-type banks from pretending they are high quality. Combining state-contingent fines with capital regulation significantly improves upon pure capital regulation.
Keywords: Banks; and; banking (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7) Track citations by RSS feed
Downloads: (external link)
http://www.richmondfed.org/publications/research/w ... /2004/pdf/wp04-2.pdf (application/pdf)
Journal Article: State-contingent bank regulation with unobserved actions and unobserved characteristics (2006)
Working Paper: State-contingent bank regulation with unobserved action and unobserved characteristics (2002)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:fip:fedrwp:04-02
Ordering information: This working paper can be ordered from
Access Statistics for this paper
More papers in Working Paper from Federal Reserve Bank of Richmond Contact information at EDIRC.
Bibliographic data for series maintained by ().