Bank capital structure and regulation: Overcoming and embracing adverse selection

Sonny Biswas*, Kostas Koufopoulos*

*Corresponding author for this work

Research output: Contribution to journalArticle (Academic Journal)peer-review

3 Citations (Scopus)
18 Downloads (Pure)

Abstract

We study bank regulation under optimal contracting, absent exogenous distortions. In equilibrium, banks offer a senior claim (deposits) to external investors and retain equity; the return on equity is higher than the return on deposits due to a scarcity of skilled bankers. Inefficient equilibria emerge under asymmetric information. Optimally designed regulation restores efficiency. Our main result is that disclosure requirements by themselves can be endogenously costly because they may push the economy from a separating equilibrium to a less efficient equilibrium that pools good and bad banks, but always improve welfare when combined with capital regulation.
Original languageEnglish
Pages (from-to)973-992
Number of pages20
JournalJournal of Financial Economics
Volume143
Issue number3
Early online date2 Jan 2022
DOIs
Publication statusPublished - 1 Mar 2022

Bibliographical note

Publisher Copyright:
© 2021 Elsevier B.V.

Structured keywords

  • AF Banking
  • AF Corporate Finance

Keywords

  • Adverse selection
  • Costly bank capital
  • Optimal capital requirements
  • Disclosure requirements

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