Bank capital structure and regulation: Overcoming and embracing adverse selection

Swarnava Biswas; Kostas Koufopoulos

doi:10.1016/j.jfineco.2021.12.001

Bank capital structure and regulation: Overcoming and embracing adverse selection

Swarnava Biswas, Kostas Koufopoulos

Economics

Research output: Contribution to journal › Article › peer-review

Abstract

We study bank regulation under optimal contracting, absent exogenous distortions. In equilibrium, banks offer a senior claim (deposits) to external investors and retain equity; the return on equity is higher than the return on deposits due to a scarcity of skilled bankers. Inefficient equilibria emerge under asymmetric information. Optimally designed regulation restores efficiency. Our main result is that disclosure requirements by themselves can be endogenously costly because they may push the economy from a separating equilibrium to a less efficient equilibrium that pools good and bad banks, but always improve welfare when combined with capital regulation.

Original language	English
Pages (from-to)	973-992
Journal	Journal of Financial Economics
Volume	143
Issue number	3
Early online date	2 Jan 2022
DOIs	https://doi.org/10.1016/j.jfineco.2021.12.001
Publication status	Published - Mar 2022

Bibliographical note

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10.1016/j.jfineco.2021.12.001

Bank Capital Structure and Regulation (Accepted JFE Version, 28-11-2021)
© 2021 Elsevier B.V. All rights reserved.This is an author-produced version of the published paper. Uploaded in accordance with the publisher’s self-archiving policy.
Accepted author manuscript, 348 KBLicence: CC BY-NC-ND

Cite this

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abstract = "We study bank regulation under optimal contracting, absent exogenous distortions. In equilibrium, banks offer a senior claim (deposits) to external investors and retain equity; the return on equity is higher than the return on deposits due to a scarcity of skilled bankers. Inefficient equilibria emerge under asymmetric information. Optimally designed regulation restores efficiency. Our main result is that disclosure requirements by themselves can be endogenously costly because they may push the economy from a separating equilibrium to a less efficient equilibrium that pools good and bad banks, but always improve welfare when combined with capital regulation.",

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