Bank leverage, welfare, and regulation

Arbeitspapier

We take issue with claims that the funding mix of banks, which makes them fragile and crisisprone, is efficient because it reflects special liquidity benefits of bank debt. Even aside from neglecting the systemic damage to the economy that banks' distress and default cause, such claims are invalid because banks have multiple small creditors and are unable to commit effectively to their overall funding mix and investment strategy ex ante. The resulting market outcomes under laissez-faire are inefficient and involve excessive borrowing, with default risks that jeopardize the purported liquidity benefits. Contrary to claims in the literature that "equity is expensive" and that regulation requiring more equity in the funding mix entails costs to society, such regulation actually helps create useful commitment for banks to avoid the inefficiently high borrowing that comes under laissez-faire. Effective regulation is beneficial even without considering systemic risk; if such regulation also reduces systemic risk, the benefits are even larger.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Discussion Papers of the Max Planck Institute for Research on Collective Goods ; No. 2018/13

Classification and Topics

• Classification: Wirtschaft ; Microeconomic Policy: Formulation, Implementation, and Evaluation ; General Equilibrium and Disequilibrium: Financial Markets ; Allocative Efficiency; Cost-Benefit Analysis ; Financial Crises ; General Financial Markets: Government Policy and Regulation ; Banks; Depository Institutions; Micro Finance Institutions; Mortgages ; Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies ; Financial Institutions and Services: Government Policy and Regulation ; Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill ; Corporate Finance and Governance: Government Policy and Regulation ; Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts ; Regulated Industries and Administrative Law
• Subject: Liquidity in banking ; leverage in banking ; banking regulation ; capital structure ; capital regulations ; agency costs ; commitment ; contracting ; maturity rat race ; leverage ratchet effect ; Basel

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Admati, Anat R. ; Hellwig, Martin
• Event: Veröffentlichung
• (who): Max Planck Institute for Research on Collective Goods
• (where): Bonn
• (when): 2018

Further information

• Handle: http://hdl.handle.net/10419/204695
• Last update: 10.03.2025, 11:42 AM CET