The Invisible Hand and the Banking Trade: Seigniorage, Risk-shifting and More

The classic Diamond-Dybvig model of banking assumes perfect competition and abstracts from issues of moral hazard,hardly appropriate when considering modern UK banking.We therefore modify the classic model to ncorporate franchise values due to market power; and risk-taking by banks with limited liability.We go further to show how the capacity of franchis evalues to mitigate risk taking maybe undermined by the bailout option; with explicit analytical results provided for the case of extreme risk-aversion.After a brief discussion of how this may impact on the distribution of income, we outline the ways in which the Vickers Report seeks to remedy these problems.