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Before the 2008 crisis, the cross-sectional skewness of banks’ leverage went up and macro risk concentrated in the balance sheets of large banks. Using a model of profit-maximizing banks with heterogeneous Value-at-Risk constraints, we extract the distribution of banks’ risk-taking parameters from balance sheet data. The time series of these estimates allow us to understand systemic risk and its concentration in the banking sector over time. Counterfactual exercises show that (1) monetary policymakers confront the trade-off between stimulating the economy and financial stability, and (2) macroprudential policies can be effective tools to increase financial stability.

This paper examines the impact of corruption, economic freedom, bank regulation and transparency on bank profitability and bank stability using a sample of 326 banks from the 19 Eurozone countries over the period 2005–2018. We use a balanced panel data set and the Arellano-Bond Generalized Method of Moments dynamic panel estimation procedure. We find that corruption and transparency have a negative effect on bank profitability and bank stability. By contrast, greater economic freedom boosts profitability and banking stability. Our results show that regulation is positively related to bank profitability and its precise effects on stability depend upon the nature of the regulation. We additionally examine how our results are affected by Governance issues and the addition of 5 other European countries from outside the Eurozone. Our overall results indicate that the impact of the variables of interest is sensitive to the precise measures chosen to calculate profitability and financial stability.

In this article, we study the transmission mechanisms of the effect of a set of 12 macroprudential policies on the risk-taking of banks using a large number of countries and a novel identification approach. Our results show that tools which aim to address vulnerabilities from interconnectedness and contagion of the financial system, such as limits on asset concentration and interbank exposures, have a positive effect on bank stability, enhancing the risk-return relation of banks and reducing leverage. Some borrower-based instruments also have a positive effect on bank stability, primarily through the leverage channel. We also find evidence that banks reduce their equity when policies impose limits on domestic and foreign currency loans. The effects are quite heterogeneous and vary considerably depending on the instrument implemented, market concentration, size of banks, liquidity, leverage and different levels of risk.

Should we break up banks and limit bailouts? We study vertical integration of deposit-taking institutions with those investing in risky equity. Integration eliminates a credit spread, reducing aggregate banking sector profitability; so while integration increases output it also entails larger, more frequent bailouts of retail customers. Bailouts boost economic activity but are costly. The optimal structure of banking depends on the efficiency of government intervention, the competitiveness of the banking sectors and shocks. Separated institutions are preferred when government bailouts are costly. Optimal bank regulation tolerates profits at investment and universal banks to limit bailouts, but imposes strict antitrust on retail banks.

Most people may not be familiar with industrial banks (IBs). Yet these financial institutions have been around for more than a century and predate the establishment of the Federal Reserve in 1913. Throughout the industry’s history, the only way a non-financial firm could enter banking was through the establishment of an IB. The reason was that the Federal government over the years has enacted legislation to block the entry of commercial firms into banking. By 1999, commercial firms had just one remaining point of entry: the acquisition or formation of an IB. A few years later, a flurry of news stories occurred in 2005, when retail giant Wal-Mart filed an application for an IB. The Federal Deposit Insurance Corporation (FDIC) held public hearings on Wal-Mart’s application and declared moratorium on new IB insurance applications. The controversy was defused when Wal-Mart withdrew its application for federal deposit insurance before the FDIC made a ruling. We examine the evolving role of regulation designed to prevent non-financial firms from owning banks and demonstrate the performance and regulation of IBs over time challenge the justification and necessity of such a separation.

The current low interest-rate environment poses new challenges to international bank regulation policies. This paper analyzes the role of the Basel regulation in this new context. We study this issue by using a DSGE model with housing and collateral constraints, both on borrowers and banks. Results show that, on the one hand, low interest rates lead to an increase in bank capital, calling for less strict international regulatory regimes. On the other hand, this environment encourages more indebtedness of borrowers, calling for a stricter regulation for macroprudential purposes. An optimal analysis of the countercyclical buffer in Basel III regulation reveals that risks to financial stability outweigh the extra accumulation of bank capital. Thus, the countercyclical buffer should be implemented more aggressively in a low interest-rate world.

We explore how large and small banks make funding decisions when system-wide bailouts are possible. We show that bank size, purely on strategic grounds, is a key determinant of banks’ leverage choices, even when bailout policies treat large and small banks symmetrically. Large banks leverage more than small banks because they internalize that their decisions directly affect bailout policies. In equilibrium, this effect is amplified by strategic spillovers to small banks since banks’ leverage choices are strategic complements. Overall, the presence of large banks makes bailouts more likely. The optimal regulation features size-dependent policies that disproportionately restrict large banks’ leverage.

We investigate how a change in regulatory oversight affects bank risk, using the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 as a setting. Using a sample of bank holding companies (BHCs) covering the period 2015Q1 through 2020Q1, we find that risk increases for large BHCs affected by a change in regulatory oversight. In addition to increasing bank level risk, affected BHCs increase their respective contribution to the systemic risk. These BHCs also experience higher profitability, increased market valuation and reduced compliance costs. Publisher PDF

With a comprehensive dataset covering 129 countries over 1995–2013, this study investigates the impact of bank globalization on financial stability. I find strong evidence that foreign bank entry increases both loan risk and the overall risk of bank failure, and threatens the financial stability of the host country. However, this link is dependent on the regulatory and institutional framework of the host country. The adverse impact from foreign banks can be mitigated when the host country has more restrictions on fee-generating activities, less stringent capital requirement, more asset diversification guidelines, a single supervisor, less government-owned banks, lower market entry barrier, and/or less effective credit information sharing. Instead, foreign bank entry could even lower bank risk when host country regulations on bank activities are highly restrictive, capital requirement is less stringent, and/or market entry barrier is low. The need to improve financial stability and that to reduce the adverse impact of foreign bank entry impose conflicting demand on some bank regulations, thus policymakers need to balance both needs and carefully condition the prudential regulations to ensure financial stability and at the same time minimize the adverse impact from foreign bank entry.

Failures and FDIC losses for community banks during the banking crises of the late 1980s and late 2000s are compared. Despite increases in risky commercial real estate (CRE) lending and more severe economic shocks in the recent crisis, failure rates were lower. We find that other changes in bank characteristics, like higher capital, made community banks more resilient to shocks. In contrast, FDIC losses on failed banks were higher. These are not explained by changes in CRE exposure or economic shocks. We find that an interest-receivable variable is predictive of failures and FDIC losses. Implications for prompt corrective action are discussed.

We investigate the influence of the institutional environment on bank capital ratios. Using a sample of 160 banks operating in the Middle East and North Africa region for the period 2004–2014, we find that, when stock markets have little presence, institutional variables significantly affect risk-weighted regulatory capital ratios but not leverage ratios. Conversely, when stock markets are more developed, only leverage ratios are influenced by institutional factors. Our results also indicate that institutional variables affect non-weighted equity-to-asset ratios of banks that are listed on a stock exchange. Our findings contribute to the bank capital structure literature and have important policy implications for developing countries.

Recent regulations increased minimum capital standards for bank holding companies. We test the effectiveness of this action in preventing bank failures during the sub-prime mortgage crisis. We find that while holding company capital is the most influential variable in the failures of banks affiliated with multi-bank holding companies, this is not the case for banks affiliated with a one-bank holding company. For these banks, the bank's own characteristics are more influential than group capital, meaning the established standards may not be universally effective.

In April 2013, the UK implemented a dual-regulation approach to financial services often referred to as twin peaks. In this paper, we assess the impact of the introduction of twin peaks regulation on the systemic risk contributions of UK financial institutions. Using a matched sample of single- and dual-regulated financial institutions, we provide evidence that twin peaks regulation resulted in a relative reduction in systemic risk for dual-regulated firms.

This paper investigates the loan loss provisioning behaviour of Italian banks during the period 2006–2013. We examine the main discretionary and non-discretionary determinants of loan loss provisions (LLPs) and explicitly investigate the role of bank's functional distance, geographic diversification and risk. Empirical results suggest that LLPs by Italian banks are mainly driven by non-discretionary factors related to expected credit risk. Moreover, we find that distantly managed banks adopt a more prudent provisioning approach, whereas small local cooperative credit banks have a lower level of LLPs. We also show that LLPs are higher in regional banking systems with higher loan concentration and lower degree of competition. Finally, we find that banks facing increasing levels of risk are not only characterised by higher LLPs, but also have a higher tendency to engage in earnings management practices to stabilise their income flows over time.

We study the relation between bank regulation stringency and announcement effects of seasoned equity offerings across 21 countries. Under a low to moderate bank regulation environment, the market reacts more positively to the bank SEO announcements for an increase in the level of bank regulation. However, the bank SEO announcement effects become more negative if the bank regulation becomes too stringent. This inverted U-shaped relation is robust after we use the exogenous cross-country and cross-year variation in the timing of the Basel II adoption as an instrument to assess the causal impact of bank regulation on SEO announcement effects. Bank regulation has no significant impact of SEO announcement effects if the equity offering is involuntary.

We ask how the structure of international banking affects the decision of a national regulator to join a banking union and to transfer regulatory powers to the supranational level. The focus is on bank supervision and bank resolution. A national regulator ignores possible gains or losses, which accrue to other jurisdictions if banks are internationally active. A supranational regulator takes these regulatory external effects into account. While supranational regulation improves total welfare, this is not necessarily the case for welfare in single countries. By analyzing the size and determinants of spillover effects we show how they constrain a country’s willingness to participate in a banking union. Our results may explain why some member states of the European Union currently hesitate to join the European Banking Union.

We study a situation in which a regulator relies on risk models that banks produce in order to regulate them. A bank can generate more than one model and choose which models to reveal to the regulator. The regulator can find out the other models by monitoring the bank, but in equilibrium, monitoring induces the bank to produce less information. We show that a high level of monitoring is desirable when the bank’s private gain from producing more information is either sufficiently high or sufficiently low. When public models are more precise, banks produce more information, but the regulator may end up monitoring more.

We investigate the effects of countercyclical prudential buffers on bank risk-taking. We exploit the introduction of dynamic loan loss provisioning in Spain, mandating that banks use historical average loss rates in their estimation of loan loss provisions. We find that dynamic loan loss provisioning is associated with reductions in timely loan loss provisioning. Banks that previously recognized loan losses in a timely fashion exhibit the greatest reductions in timeliness and consequently extend loans to riskier borrowers with lower accounting quality. Our results have policy implications for the debate on the use of financial reporting requirements in mitigating capital pro-cyclicality.

This paper investigates the impact of regulation and ownership on the performance of banks in 19 countries in the Middle East and North Africa (MENA) region. We test the hypothesis that the effect of regulation on bank profitability depends on the type of ownership structure. The public and private views of bank regulation are also tested along with the interaction of bank regulation and ownership. We find regulation measures to have a strong influence on bank profitability, whereas ownership structure seems to play a limited role in explaining bank performance in the MENA region. The results support the private view of bank regulation and suggest that capital requirements and private monitoring when interacted with ownership concentration exert a strong influence on bank profitability. When the analysis is done separately for conventional and Islamic banks, we find that the impact of bank regulations though strongly significant, does not depend on the type of ownership structure prevailing in conventional banks. In contrast, regulatory effects seem to be important drivers of profitability of Islamic banks. Therefore, it is very important for policy makers in these countries not to treat the two types of banks identically when setting up and implementing bank regulations especially during the COVID-19 pandemic.

Pandemics lead to a sudden decline in the level of economic activities. Lending institutions reduce credit supply to businesses due to fears of rising bad debts during a pandemic. This paper highlights some approach to financial regulation and bank supervision during a pandemic such as the SARS and COVID-19 pandemic. I show that financial regulation during a pandemic can be enhanced by diversifying the financial system, maintaining adequate liquidity in the financial system, stimulating financial institutions to provide more credit, delaying the recognition of significant increase in credit risk, lowering the reference interest rate to encourage more lending, and providing stimulus packages to the general economy. I also suggest measures to improve bank supervision during a pandemic which include adopting a flexible supervisory framework, modifying bank supervisory examinations, using ad-hoc stress tests, releasing the countercyclical capital buffer to banks, and increase the use of regulatory forbearance. The implication of these approaches to coping with a pandemic is that these measures can help to ensure the survival of small and large businesses and financial institutions who rely on credit from financial institutions. It can also help to preserve jobs and help to reduce the long term damage to the economy caused by the pandemic.

A puzzle of China’s shadow banking system is its stark growth since the 2008 Subprime Crisis, which is in sharp contrast to most of countries. We present a model to explain why the shadow banking activities have been allowed to expand with the full awareness of regulators in China. In the presence of local government intervention, which tends to distort the banks’ portfolio choices towards inefficient low-quality projects, the policy combination of formal banking sector credit tightening and shadow banking sector loosening forces banks to improve credit quality. This is because shadow banking assets are less diversified than commercial bank assets, thereby subject to higher bank run risk, which forces banks to improve the quality of shadow banking assets. Negative shocks to project quality may trigger information production in the shadow banking sector and prevent banks from providing funding to efficient projects, which creates additional welfare losses. This result provides a rationale for China's new regulations on shadow banking sector since 2018 in the background of increasing risks.

Motivated by the unprecedented high levels of recent economic policy uncertainty in Europe and the globe, this paper examines the relationship between economic policy uncertainty and bank stability, as well as the conditioning effects of bank regulation and supervision on this relationship. Using a sample of around 900 commercial banks in eight major European countries over the period 2005-2014, economic policy uncertainty has been consistently linked to a sharp decrease in bank stability, once other traditional drivers are controlled for. More importantly, this paper offers insight into how strengthening bank regulation and supervision, particularly regulations on activity restrictions, capital stringency, official supervisory power, and private monitoring, cushions the adverse effects of policy uncertainty on bank stability.

This study investigates the effect of the balance sheet approach, where financial reporting focuses on asset and liability valuation, on the usefulness of the capital adequacy ratio in the evaluation of bank default risk by credit rating agencies. We examine Japanese banks, which play the central role in the Japanese economy, and whose capital adequacy ratios are affected by the fair value measurement under the balance sheet approach. We adopt Demerjian’s (2011) approach to develop a bank-level measure of balance sheet focus. Although we find a significant positive correlation between the slack of the regulatory capital adequacy ratio and issuer rating, we find that this positive correlation is significantly weakened as a bank’s dependence on the balance sheet approach increases. The results suggest that the regulatory capital adequacy ratio based on a bank’s accounting information provides useful information for the evaluation of default risk but that rating agencies discount capital information that relies heavily on the balance sheet approach when estimating a bank’s default risk.

We investigate the development of non-performing loans (NPLs) held by European banks throughout the economic cycle. During the global financial crisis and the subsequent sovereign debt crisis, banks from all European countries experienced a substantial increase in NPLs. We find that these increases are mainly associated with macroeconomic determinants and characteristics of banks’ business models. Substantial differences across countries exist in the duration and efficiency of NPL resolution after the crisis. We exploit cross-country and time-variant differences in insolvency and contract enforcement procedures to document that the outcome of NPL resolution is associated with the duration and costs of insolvency and contract enforcement during the economic recovery phase. Our findings suggest that the design of a country’s legal regime can ensure swift NPL resolution during the recovery phase, while the build-up of NPLs during a crisis is mainly attributable to economic conditions.

Banks always have someone watching over their shoulders, gauging compliance with law, evaluating risk, and correcting behavior. This is bank supervision. We expect a lot from bank supervision. It is supposed to ensure that banks operate in a safe and sound manner, mitigate systemic risk in the larger financial system, promote fair and efficient markets, protect consumers and other bank customers, and maybe more. Legal scholarship scrutinized bank supervision and asks whether legal changes could help supervision more completely reach its goals. Often, however, legal scholarship passes briefly over bank supervision, instead focusing bank regulation (the establishment of the legal rules that banks must operate within). This literature review summarizes existing legal scholarship on banking supervision, examines why supervision is overlooked, and provides possible avenues for future work on supervision.

This paper presents a bank capital structure model in which equity holders can increase asset risk once debt is in place. I study the effects of capital requirements and subsidized deposit insurance on the bank's privately optimal funding and operational risk level. The model predicts that there are synergetic effects of regulation and market discipline. When the regulator sets the capital charge and deposit insurance premium payments sufficiently high for a risky portfolio, the bank commits to the low-risk asset portfolio by setting a lower leverage ratio. This market discipline effect disappears when the regulatory costs become too high.

Bank leverage constraints can emerge from regulatory capital requirements as well as from central bank collateral requirements in reserve lending facilities. While these two channels are usually examined separately, we are able to compare them with the help of a bank money creation model in which central bank reserves have to be acquired to settle interbank liabilities. In particular, we show that with regard to bank monitoring, monetary policy via collateral requirements leads to a unique collateral leverage channel, which cannot be replicated by standard capital requirements. Through this channel, banks can expand loan supply and deposit issuance when they face liquidity constraints, by raising the collateral value of their loans with tighter monitoring of firms. The collateral leverage channel can improve welfare beyond standard bank capital regulation. Our results may inform current policy debates, such as the design of central bank collateral frameworks or the question whether monetary policy remains effective in times with large central bank reserves.

This paper exploits the information content of option markets to offer fresh insight into the Too-Big-to-Fail (TBTF) problem for banks. I employ option prices to construct a forward-looking measure of bank exposure to significant price drops (i.e. tail-risk) and explore cross-sectional differences between large banks with at least $50B in assets identified as systemically important and smaller banks. I document a permanent increase in the average tail-risk of the U.S. banking industry as a whole following the Global Financial Crisis (GFC), except for banks above the $50B size threshold. I argue that the stark post-crisis difference in tail-risk for banks above and below the $50B threshold is consistent with the notion that the TBTF status of above 50B banks was reinforced by the series of bailouts targeted at them during the crisis and their subsequent designation as systemically important by the Dodd-Frank Act. This in turn raised investor expectations of future bailouts for above 50B banks and reduced their perceived exposure to downside risk as captured by the tail-risk measure.

This paper assesses the value of multiple requirements in bank regulation using a novel empirical rule‑based methodology. Exploiting a dataset of capital and liquidity ratios for a sample of global banks in 2005 and 2006, we apply simple threshold-based rules to assess how different regulations individually and in combination might have identified banks that subsequently failed during the global financial crisis. Our results generally support the case for a small portfolio of different regulatory metrics. Under the objective of correctly identifying a high proportion of banks which subsequently failed, we find that a portfolio of a leverage ratio, a risk-weighted capital ratio, and a net stable funding ratio yields fewer false alarms than any of these metrics individually – and at less stringent calibrations of each individual regulatory metric. We also discuss how these results apply in different robustness exercises, including out-of-sample evaluations. Finally, we consider the potential role of market-based measures of bank capitalisation, showing that they provide complementary value to their accounting-based counterparts.

The deferred recognition of COVID-induced losses at banks in many countries has reignited the debate on regulatory forbearance. This paper presents a model where the public's own political pressure drives regulatory policy astray, because the public is poorly informed. Using probabilistic game stages, the model parameterizes how time consistent policy is. The interaction between political motivations and time consistency is novel and complex: increased policy credibility can entice the politically-motivated regulator to act in the public's best interest, or instead repel it from doing so. Considering several regulatory instruments, the paper probes the nexus of political pressure, perverse bank incentives and time inconsistent policy.

Do banks enable organized crime? Does bank regulation insulate financial intermediation from criminal activity? I address these questions using evidence from the drug trade in Mexico, finding that local drug cartel activity causes an increase in bank deposits. Branch networks grow in affected areas; this growth is not driven by increased lending opportunities. Post-election of a "law-and-order" government, effects attenuate, with liquidity flowing into branches of U.S. banks along the border. I interpret this as evidence that "finance follows crime" in weak institutional environments, and that, absent transnational policy coordination, regulatory arbitrage via cross-border liquidity flows undermines banking regulation.

This article has teased out Anne Flemings’s interests and the overarching themes in her research. It shows how these themes and interests influenced the direction of her research in the hope that these ideas will continue to be influential in the years to come. Her scholarship tells a compelling story of individual lives, consumerism, and the pitfalls of leaving capitalism unbowed. The significance of Anne’s scholarship is not only owing to her substantive claims but also to her approach. She mapped out elaborate histories of lending, although she primarily assessed consumer finance law and economic policy by looking at their impact on the end user. There is much to be gained by taking such an approach and from using the consumer as a lens to examine banking and financial regulation.

The general view underlying bank regulation is that bank disclosures provide market discipline and reduce banks’ risk-taking incentives. We show that bank disclosures can increase bank leverage and bank risk. The reason stems from the interaction between insured and uninsured debt. Bank disclosures reduce the agency problem between uninsured debt and equity, thereby lowering the cost of leverage for banks. By issuing uninsured short-term debt that is repaid ahead of insured deposits when economic conditions deteriorate, banks dilute insured deposits. Higher levels of uninsured short-term debt increase the subsidy provided by deposit insurance, which increases banks’ risk-taking incentives. We identify conditions under which this negative leverage effect dominates the standard market discipline effect, so that providing market discipline through bank disclosures increases banks’ risk.

This paper examines how the capital structure of non-financial firms is affected by international variation in bank regulation. A concise model yields an estimating equation that relates a firm's capital structure to bank regulatory variables and their interactions with the tax rate reflecting the tax deductibility of interest. We identify an effect of bank regulation on leverage by considering establishments of the same multinational firm located in different countries. Our results indicate that capital regulation stringency and official supervisory power are negatively related to firm leverage, while restrictions on non-lending activities and on financial conglomerates vary positively with firm leverage. High tax rates mitigate these effects.

This article argues that there is a fundamental mismatch between the nature of finance and current approaches to financial regulation. Today’s financial system is a dynamic and complex ecosystem. For these and other reasons, policy makers and market actors regularly have only a fraction of the information that may be pertinent to decisions they are making. The processes governing financial regulation, however, implicitly assume a high degree of knowability, stability, and predictability. Through two case studies and other examples, this article examines how this mismatch undermines financial stability and other policy aims. This examination further reveals that the procedural rules meant to promote accountability and legitimacy often fail to further either end. They result instead in excessive expenditures before new rules are adopted, counterproductive efforts to perfect ever more detailed rules, and too little re-evaluation of existing rules in light of new information or changed circumstances. The mismatch between the nature of finance and how finance is regulated helps to explain why financial regulation has failed in the past and why it will likely fail again. It also suggests the need for a new approach to financial regulation, one that acknowledges the limits of what can be known given the realities of today’s complex and constantly evolving financial ecosystem.

Stress-tests provide complementary information about banks’ risk exposures. Recent empirical evidence, however, has uncovered potential inaccuracies in stress-test based assessments. We investigate the regulatory implications of these inaccuracies. Without stress-tests, the regulator cannot observe bank’s type, and sets the same requirement across banks. Stress-testing provides a noisy signal about the banks’ types, and enables bank specific surcharges, which can improve welfare. Yet, when stress-tests are less accurate, they distort banks’ ex-ante incentives to improve their risk-return profiles. As a result, higher capital surcharges can lead banks to be more risky. The optimal surcharge depends on the accuracy of stress-tests, and can be zero.

The idea of separating retail and investment banking remains controversial. Exploiting the introduction of UK ring-fencing requirements in 2019, we document novel implications of such separation for credit and liquidity supply, competition, and risk-taking via a funding structure channel. By preventing conglomerates from using retail deposits to fund investment banking activities, this separation leads conglomerates to rebalance their activities towards domestic mortgage lending and away from supplying credit lines and underwriting services to large corporates. By redirecting the benefits of deposit funding towards the retail market, this rebalancing reduces the cost of credit for households, without eroding lending standards. However the rebalancing also increases mortgage market concentration and risk-taking by smaller banks via indirect competition effects.

We investigate regulatory arbitrage during the G20’s global derivatives market reform. Using hand-collected data on staggered reform progress, we find that banks shift their trading towards less regulated jurisdictions. The result is driven by agenda items – such as the promotion of central clearing – that are costly, but do not directly benefit banks. We further document that subsidiaries in jurisdictions with more reform progress shift to riskier portfolios. Alleviating endogeneity concerns we show that reform progress is primarily driven by structural (time-invariant) factors.

This paper studies the optimal determination of deposit insurance (DI) when bank runs are possible. In a variety of environments, the welfare impact of changes in the level of deposit insurance coverage exclusively depends on three sufficient statistics: the sensitivity of the likelihood of bank failure with respect to the level of DI, the utility gain induced by preventing the marginal bank failure, which can be expressed in terms of the drop in depositors' consumption, and the direct social cost of intervention in bank failure scenarios, which can be expressed in terms of the probability of bank failure, the marginal cost of public funds, and the mass of partially insured depositors. The same expression applies a) when banks face perfect ex-ante regulation and b) when banks are not allowed to react to policy changes. Under imperfect regulation, because banks do not internalize the fiscal impact of their actions, changes in the behavior of banks induced by varying the level of DI (often referred to as moral hazard) only affect the level of optimal DI directly through a fiscal externality, but not independently. We characterize the wedges that determine the optimal ex-ante regulation, which map to liability-side regulation (e.g., deposit insurance premia) and asset-side regulation. Finally, we explore the quantitative implications of our approach through a direct measurement exercise and a model simulation.

I study positively and normatively the role of bank heterogeneity in the macroeconomy. I build an empirically-motivated macroeconomic model with a banking sector that features uninsurable idiosyncratic rate of return shocks, endogenous markups, costly default, and endogenous entry. The framework highlights a trilemma for bank regulation: the government cannot simultaneously improve financial competition, efficiency, and stability. Three validated channels impact the transmission of policy regimes on the macroeconomy: an economies of scale channel from larger banks being more efficient, an endogenous competition channel from larger banks charging higher markups, and a financial stability channel from smaller banks facing shorter distance to default. The trilemma extends to deposit insurance schemes, heterogeneous capital requirements, the too-big-to-fail hazard, and optimal constrained efficient allocations. I discuss implications of the framework for the ongoing rise of banking concentration, emergence of fintech credit, targeted stabilization policies like bank-level bailouts and liquidity facilities, and intermediary asset pricing.

Critics of recent regulation to increase minimum bank capital requirements contend that this policy will increase the cost of doing business for banks. We investigate the potential impact of heightened capital requirements on banks’ cost of capital. In the cross-section, banks’ cost of equity, measured by the implied cost of capital (ICC), and banks’ cost of debt decline when equity capital increases. The negative association between capital and banks’ ICC is stronger after the onset of the financial crisis, consistent with prior work suggesting that equity is more valuable during periods of financial distress. The negative association between capital and banks’ cost of equity and debt, compensates for the difference in the costs of these sources of financing. As a consequence, the overall cost of capital remains unaltered when capital increases. Thus, our findings do not offer support the claim that additional equity has a negative impact on credit because equity increases banks’ cost of capital. An exception to these findings is found in the sample of large banks. There is no discernible association between capital and the costs of equity and debt of large banks and their WACC increases when they substitute debt with more expensive equity.

Most research on the run-up in home prices before the Great Recession has focused on types of excessive demand—loose lending, foreign savings, loose monetary policy, speculation, bank deregulation, federal housing subsidies, etc. The focus on excess demand led to fatalism about the collapse in homebuilding that began in 2006 and the eventual recession and financial crisis that followed. Regardless of the sources of excess demand, a consensus developed that American spending had become unsustainably high because of a housing bubble and that demand needed to be reduced. Using a broad array of evidence, we find that constrained supply of new housing in key urban centers was the primary trigger for high home prices before the crisis. The recession and the financial crisis were the result of deliberate contractions of demand—both generally and specifically in residential investment—that were neither useful nor necessary. First, tightening monetary policy reduced aggregate spending and encouraged negative sentiment about real estate. Then, policy changes tightened lending standards and depressed housing markets for years after the 2008 financial crisis. A monetary policy regime targeting stable nominal income growth would have dramatically improved the economy during and after 2008.

We investigate how overlapping activities of bank regulators and supervisors and bank auditors influence banks’ internal control quality, auditor-client contracting (audit fees and audit effort), and financial statement reliability. Using material weaknesses in internal controls as a proxy for internal control quality, we find that banks exhibit fewer internal control problems than do nonbanks. Using audit fees, earnings announcement lags and audit report lags as alternative proxies for audit effort, we find that auditors expend less effort in audits of banks than in audits of nonbanks. Despite the lower audit effort, we find that banks report fewer and less severe restatements of prior period financial statements than do nonbanks, suggesting that the aggregate efforts of bank regulators/supervisors and bank auditors generate more reliable financial reporting by banks. A notable implication of our study is that bank regulation and supervision alter the auditor-client contracting equilibrium, with a notable benefit being an increase in banks’ financial reporting quality.

The bank literature has documented theoretical and empirical evidence of a “diabolic loop” in the sovereign-bank nexus. Banks have a concentrated risk exposure in domestic government bonds. In the European banking union, this has led to a proposal to create European safe bonds (ESBies). Securitized sovereign bond-backed securities would facilitate geographical sovereign diversification, hence contributing to bank stability. But will banks in low-rated countries invest in safe bonds? This paper offers two new explanations for the home bias in government bond holdings: a sovereign-based rating cap on corporates and the existence of a ‘bank tax’. These are complementary to the four explanations offered in the literature: risk shifting, gambling for resurrection, moral suasion, and a way to store liquidity for financing future investment. Collectively they cast doubt on a demand-led approach to investment in safe bonds by banks in low-rated countries. Bank regulations such as constraints on large exposure or risk-based capital on credit risk concentration will be needed if the objective is to break the so-called “deadly embrace”.

Using 1,584 listed banks from 65 countries during the COVID-19 pandemic, we conduct the first broad-based international study examining the effect of the pandemic on bank systemic risk. We find the pandemic increases systemic risk across countries. The effect operates through government policy and bank default risk channels. Additional analysis suggests that the adverse effect of the pandemic on systemic stability is more pronounced for large, highly leveraged, riskier, high loan-to-asset, undercapitalized, and low network centrality banks. However, this effect is moderated by formal bank regulation (e.g., deposit insurance) and ownership structure (e.g., foreign and government ownership), and informal institutions (e.g., culture and trust).

A wide range of approaches has been applied to address banking and other financial crises. The nature of the approach depends on the nature of the crisis, its origins, evolution and context. Systemic banking crises are among the most common and costly to address. The experiences of the three major international financial crises of the past 25 years – the Asian Financial Crisis, the Global Financial Crisis, and the European Debt Crisis – offer critical lessons regarding the most effective approaches in tackling bank solvency during a systemic crisis. One of the most common and also effective methods has been the transfer of non-performing loans (NPLs) to an Asset Management Company (AMC) that performs workouts or liquidates stressed loan portfolios at a more opportune time to amortize losses. In most cases the use of AMCs has delivered positive results for the taxpayer. Contemporary consensus as regards tackling bank solvency during a systemic financial crisis focuses heavily on prevention of government bailouts in order to protect state finances and curb moral hazard. However, an overly dogmatic focus on preventing public financial support in the context of a systemic bank solvency crisis may place insurmountable obstacles to the use of state-backed AMCs and other forms of resolution of NPLs and bank recapitalization. This paper provides a new perspective on the common belief that public support in the context of systemic bank insolvency – i.e. bank bailouts – is an inefficient use of public funds or conducive to moral hazard. Our study finds that state-backed AMCs can be effective in recapitalizing banking systems, depending on the modus operandi of the restructuring, funding and the conditions attached to the fiscal backstop. With respect to systemic banking crises or those caused by exogenous factors, such as the unprecedented disruption of economic activity due the COVID-19 pandemic, preservation of financial stability and not containment of moral hazard should be policy-makers’ predominant goal. Thus, we suggest that a combination of balance sheet restructuring and the use of AMCs to manage NPLs is the optimal approach.

We study the disclosure policy of a regulator overseeing a monitor with reputation concerns. The monitor faces a manager, who chooses how much to manipulate based on the monitor’s reputation. Reputational incentives are strongest for intermediate reputations. Instead of providing transparency, the regulator’s disclosure policy aims to keep the monitor’ s reputation intermediate, even at the cost of diminished incentives. Beneficial schemes feature random delay. Commonly used ones, which feature immediate disclosure or fixed time delay, destroy reputational incentives. Surprisingly, the regulator discloses more aggressively when she has better enforcement tools.

“Rent-a-bank” arrangements are the vehicle of choice for subprime lenders seeking to avoid state consumer protection laws. In a rent-a-bank arrangement, a nonbank lender contracts with a bank to make loans per its specifications and then buys the loans from the bank. The nonbank lender then claims to shelter in the bank’s federal statutory exemptions from state regulation. The validity of these arrangements is the most bitterly contested legal question in consumer finance. The rent-a-bank phenomenon is a function of a binary, entity-based regulatory approach that treats banks differently than nonbanks and that treats bank safety-and-soundness regulation as a substitute for consumer protection laws. The entity-based regulatory system is based on the dated assumption that transactions align with entities, such that a single entity will perform an entire transaction. Consumer lending, however, has become “disaggregated,” so the discrete parts of lending—marketing, underwriting, funding, servicing, and holding of risk—are frequently split up among multiple, unaffiliated entities. The binary, entity-based regulatory system is a mismatch for disaggregated transactions involving a mosaic of bank and non-bank entities. The mismatch facilitates regulatory arbitrage of consumer protection laws through rent-a-bank arrangements, as nonbanks claim favorable regulatory treatment by virtue of the involvement of a bank in parts of a transaction. The vitality of rent-a-bank arrangements depends on legal doctrine. This Article shows that the “valid-when-made” doctrine used to support rent-a-bank arrangements, is not, as claimed, a well-established, centuries old, “cardinal rule” of banking law, but a modern fabrication. The doctrine is not valid, but made up. Because the doctrine never existed historically, it cannot be essential for the smooth functioning of credit markets. This Article argues that the better approach to disaggregated transactions is a presumption that bank regulation does not extend beyond banks, coupled with an anti-evasion principle that looks to substance over form. Such an approach would create greater certainty about the legality of transactions, while effectuating both state consumer protection laws and federal bank regulation policy.

We study how banks react to policy announcements during a representative policy cycle involving consultation and publication using a novel dataset on the population of all mortgage transactions and regulatory risk assessments of banks. We demonstrate that banks likely to benefit from lower capital requirements increase the size of this capital relief by permanently investing into low risk assets after the publication of the policy. In contrast, there is no evidence that they already reacted to the early step of the development of the policy, the publication of the consultation paper. We show how these results can be used to estimate a lower bound on the cost of capital for smaller banks, for which such estimates are typically difficult to obtain.

This paper studies the links between financial stability and the architecture of financial systems. We review the existing literature and provide organizing frameworks for analyzing three empirically important aspects of financial architecture: The rise of non-bank financial intermediaries, the regulatory response to these structural changes, and the emergence of complex interbank networks. One of our main new results is a necessary and sufficient condition for whether non-bank intermediaries are immune to runs in an extended version of the Diamond-Dybvig model.