The Rents of Banking A Public Choice Approach to Bank Regulation

The rise of a crisis-prone banking sector and its political power has received significant attention following the most recent financial crisis. The crisis sparked a growing interest in understanding how and why we have created a world of large, unstable banks. Excessive banking activity arose by design. Using theoretical models from a public choice perspective, the thesis rationalizes this trend as the outcome of political decisions. The thesis argues that the asymmetric information on the costs of banking regulation (and on the social value of making credit available to selected borrowers) incentivizes politicians to combat banking panics and equally preserve electoral support through the smart design of banking rules, i.e. the steering of credit flows and most importantly the provision of an underpriced safety net for the banking business. However, this incentive structure has produced a regulatory framework that now favors the emergence of large, systemically important financial institutions and catalyzes moral hazard behavior. Once established, the created rents for banking activity are likely to persist due to political and institutional lock-in effects. This thesis discusses the linkages between banking regulation, rents and financial intermediation in five chapters, which can be broadly structured into two parts.