Banks face two different kinds of moral hazard problems: asset substitution by shareholders (e.g., making risky, negative net present value loans) and managerial rent seeking (e.g., investing in inefficient “pet” projects and consuming perquisites that yield private benefits). The privately...

We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures, regulators bail out creditors. Anticipation of this...

We develop a theory of optimal bank leverage in which the benefit of debt in inducing loan monitoring is balanced against the benefit of equity in attenuating risk-shifting. However, faced with socially-costly correlated bank failures, regulators bail out creditors. Anticipation of this...

We consider a model in which the threat of bank liquidations by creditors as well as equity-based compensation incentives both discipline bankers, but with different consequences. Greater use of equity leads to lower ex ante bank liquidity, whereas greater use of debt leads to a higher...

This paper examines the roles of ethics, culture, and higher purpose in banking, defining these concepts and discussing how they are related. Developments in these areas since the financial crisis are discussed in the context of governance in banking. The theoretical and empirical research on...

This paper provides a brief assessment of how organizational higher purpose, ethics, culture and corporate governance have evolved in banking since the financial crisis. It concludes that we need to strengthen capital ratios and equity governance in banking to improve ethics and culture, and...

We review the economics of bank regulation as developed in the contemporary literature. We begin with an examination of the central aspects of modern banking theories in explaining the asset transformation function of intermediaries, optimal bank liability contracts, coordination problems...

We develop a theory of banking that explains why banks started out as commodities warehouses. We show that warehouses become banks because their superior storage technology allows them to enforce the repayment of loans most effectively. Further, interbank markets emerge endogenously to support...

We use a labor-search model to explain why the worst employment slumps often follow expansions of household debt. We find that households protected by limited liability suffer from a household-debt-overhang problem that leads them to require high wages to work. Firms respond by posting high...

Until recently, regulatory discourse has paid scant attention to the issue of organizational culture in banking. Yet ethical lapses and systematic weaknesses exposed in the 2007-09 financial crisis suggest that future policy dialogue is unlikely to ignore culture's significance. Drawing from an...