The Economics of Bank Regulation

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 leading to bank failures and their empirical significance, and the regulatory interventions suggested by these considerations. In particular, we focus on regulations aimed primarily at ameliorating deposit-insurance-related moral hazards, such as cash-asset reserve requirements, risk-sensitive capital requirements and deposit insurance premia, and bank closure policy. Moreover, we examine the impact of the competitive environment (bank charter value) and industry structure (scope of banks) on these moral hazards. We also examine the implications of banking theory for alternatives to deposit insurance