When bigger isn’t better: Bail outs and bank behaviour

The traditional theory of commercial banking explains maturity transformation and liquidity provision assuming no asymmetric information and no excess profits. It captures the possibility of bank runs and business cycle risk; but it ignores the moral hazard problems connected with risk-taking by large banks counting on state bail outs. In this paper market concentration and risk-shifting is incorporated in an analytically tractable fashion; and the modified framework is used to consider measures to restore competition and stability--including, in particular, those recommended for the UK by the Independent Commission on Banking (2011), chaired by Sir John Vickers.