Do low interest rate environments lead to greater bank risk-taking? We show that, when banks can adjust their capital structures, reductions in real interest rates lead to greater leverage and higher risk for any downward sloping loan demand function. However, if the capital structure is fixed, the effect depends on the degree of leverage: following a decrease in interest rates, well capitalize...

We construct a Risk Management Index (RMI) to measure the strength and independence of the risk management function at bank holding companies (BHCs). U.S. BHCs with higher RMI before the onset of the financial crisis have lower tail risk, lower non-performing loans, and better operating and stock return performance during the financial crisis years. Over the period 1995 to 2010, BHCs with a hig...

This paper proposes a model in which bank runs are closely related to the state of the business cycle. The benchmark model shows that, in a market economy, there are welfare losses due to the existence of bank runs. Extensions of the model explore the welfare effects of various government policies. The results suggest that an interest-cap deposit insurance scheme is an efficient policy to preve...

a stochastic frontier cost function indicates that the annual cost of complying with the anti-redlining Community Reinvestment Act (CRA) is $171,000 per thrift institution, roughly 2.3 percent of variable costs. But compliance cost is significantly less than the estimated 21 percent cost inefficiency. Based on published estimates of the incremental number of mortgage loans induced by CRA, the m...

Yes, size actually matters. This paper models the strategic interaction between banks and the government when bailouts are possible. I analyze how imperfect common knowledge about the government’s bailout policy affects the ex-ante leverage choice for each bank. Large banks, by internalizing the effect of their size on the likelihood of being bailed out, are willing to take more leverage. In eq...

One of the important functions of financial intermediation is intertemporal risk smoothing. This paper studies the effects of a production shock in a closed economy and compares the abilities of market-based and bank-based financial systems in processing the shock. The analysis of the shock propagation indicates that a competitive banking system may collapse in absence of a proper regulation. P...

Retail certificates of deposit provide financial institutions with funds and depositors with income. Because interest rates and terms on deposits vary, understanding the reasons for the variation should help participants in this market make better decisions. This study explores interest rates and terms on deposit offerings from banks and thrifts while controlling for risk, service, and demograp...

We use a model of mean-shifting investment technologies to study the relationship between market structure, risk taking and social welfare in lending markets. Introduction of loan market competition is shown to reduce lending rates and to generate higher investments without increasing the equilibrium bankruptcy risk of borrowers. Hence, there need not be a tradeo€ between lending market competi...

We investigate the trade-off between the risk-sharing gains enjoyed by more interconnected firms and the costs resulting from an increased risk exposure. We find that when the shock distribution displays “fat” tails, extreme segmentation into small components is optimal, while minimal segmentation and high density of connections are optimal when the distribution exhibits “thin” tails. For less ...

If there were no impediments to the ‡ow of capital across space, then the returns to capital should be equalized. We provide evidence to the contrary. There are large di¤erences in the return to comparable investments across di¤erent towns in the state of Tamil Nadu in South India. We explore why these di¤erences are not arbitraged away –and suggest that if an insider has monopoly power in arbi...