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Financial Regulation: Theory

Paper Session

Friday, Jan. 5, 2018 8:00 AM - 10:00 AM

Loews Philadelphia, Commonwealth Hall D
Hosted By: American Finance Association
  • Chair: Marcus Opp, Stockholm School of Economics

Redemption Fees and Information-Based Runs

Stephen Lenkey
,
Pennsylvania State University
Fenghua Song
,
Pennsylvania State University

Abstract

We study how the imposition of a redemption fee affects runs on financial institutions when investors are asymmetrically informed about fundamentals. Although the fee eliminates the first-mover advantage by internalizing the payoff externality and, therefore, discourages runs by informed investors, it also alters the information externality by influencing uninformed investors' learning and may, thereby, either increase or decrease overall run potential. Additionally, the fee may create a last-mover advantage for the informed, resulting in a wealth transfer from uninformed to informed investors. These effects render the fee's impact on welfare and the investors' propensity to run preemptively ambiguous.

The Incentive Channel of Capital Market Interventions

Michael Lee
,
Federal Reserve Bank of New York
Daniel Neuhann
,
University of Texas-Austin

Abstract

We study how policy interventions designed to jump-start liquidity in frozen collateralized lending markets affect the private incentives to maintain or produce high-quality assets. Interventions may reinforce or destroy private incentives depending on whether expected future liquidity increases the relative value of owning a high-quality asset. When adverse selection stems primarily from uncertainty about returns on investment opportunities, intervention boosts private incentives and leads to faster recovery. In contrast, if adverse selection stems from the collateral value of assets, markets become subject to ``intervention traps'' -- expectations concerning future interventions eliminate private incentives to improve the quality of collateral, which stunts recovery and warrants continued market intervention. The adverse effects of interventions may therefore be particularly pronounced in settings where dispersed collateral values are at the root of market breakdowns to begin with.

Optimal Supervisory Architecture and Financial Integration in a Banking Union

Jean-Edouard Colliard
,
HEC Paris

Abstract

Both in the United States and in the Euro Area, bank supervision is the joint responsibility of local and central supervisors. I study a model in which local supervisors do not internalize as many externalities as a central supervisor. Local supervisors are more lenient, but banks also have weaker incentives to hide information from them. These two forces can make a joint supervisory architecture optimal, with more weight put on centralized supervision when cross-border externalities are larger. Conversely, more centralized supervision endogenously encourages banks to integrate more cross-border. Due to this complementarity, the economy can be trapped in an equilibrium with both too little central supervision and too little fi nancial integration, when a superior equilibrium would be achievable.

The Redistributive Effects of Bank Capital Regulation

Elena Carletti
,
Bocconi University
Robert Marquez
,
University of California-Davis
Silvio Petriconi
,
Bocconi University

Abstract

We build a general equilibrium model of banks’ optimal capital structure, where investors are reluctant to invest in financial products other than deposits, and where bankruptcy is costly. We first show that banks raise both deposits and equity, and that investors are willing to provide equity only if adequately compensated. We then introduce (binding) capital requirements and show that: (i) it distorts investment away from productive projects toward storage; or (ii) it increases the cost of raising capital for banks, with the bulk of this cost accruing to depositors. These results hold also when we extend the model to incorporate various rationales justifying capital regulation.
Discussant(s)
Douglas Diamond
,
University of Chicago
William Fuchs
,
University of Texas-Austin and University Carlos III of Madrid
Martin Oehmke
,
London School of Economics
David Martinez-Miera
,
University Carlos III
JEL Classifications
  • G2 - Financial Institutions and Services