Economics at your fingertips  

Bank Moral Hazard and Market Discipline

Elena Carletti ()

FMG Discussion Papers from Financial Markets Group

Abstract: We show that market discipline can be effective in resolving the moral hazard problem which arises when depositors do not know whether bankers are monitoring or not the projects they finance. Demandable debt, by allowing the possibility of bank runs, can induce bankers to monitor. However, market discipline comes at a cost. When depositors are not equally informed about the future value of bank assets, withdrawals caused by a liquidity shock may be confused with future insolvency and cause uninformed depositors to precipitate a run. Likewise, withdrawals due to upcoming insolvency may be confused with a liquidity shock and dissuade depositors from running. Bank runs are, therefore, costly and imperfect disciplinary devices for bankers. Our results offer a new perspective on the debate on market versus regulatory discipline of banks.

Date: 1999-05
References: Add references at CitEc
Citations: View citations in EconPapers (12)

Downloads: (external link) (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Access Statistics for this paper

More papers in FMG Discussion Papers from Financial Markets Group
Bibliographic data for series maintained by The FMG Administration ().

Page updated 2024-07-23
Handle: RePEc:fmg:fmgdps:dp326