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An Incentive Approach to Banking Regulation
Author(s) -
GIAMMARINO RONALD M.,
LEWIS TRACY R.,
SAPPINGTON DAVID E. M.
Publication year - 1993
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1993.tb04766.x
Subject(s) - moral hazard , asset (computer security) , adverse selection , deposit insurance , asset quality , incentive , business , bank failure , quality (philosophy) , capital requirement , bank regulation , actuarial science , capital (architecture) , information asymmetry , capital adequacy ratio , regulator , finance , economics , microeconomics , computer science , computer security , history , philosophy , archaeology , epistemology , biochemistry , chemistry , gene
We examine the optimal design of a risk‐adjusted deposit insurance scheme when the regulator has less information than the bank about the inherent risk of the bank's assets (adverse selection), and when the regulator is unable to monitor the extent to which bank resources are being directed away from normal operations toward activities that lower asset quality (moral hazard). Under a socially optimal insurance scheme: (1) asset quality is below the first‐best level, (2) higher‐quality banks have larger asset bases and face lower capital adequacy requirements than lower‐quality banks, and (3) the probability of failure is equated across banks.