Obstacles to Optimal Policy: The Interplay of Politics and Economics in Shaping Bank Supervision and Regulation Reforms

This paper provides a positive political economy analysis of the most important revision of the U.S. supervision and regulation system during the last two decades, the 1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA). We analyze the impact of private interest groups as well as political-institutional factors on the voting patterns on amendments related to FDICIA and its final passage to assess the empirical importance of different types of obstacles to welfare-enhancing reforms. Rivalry of interests within the industry (large versus small banks) and between industries (banks versus insurance) as well as measures of legislator ideology and partisanship play important roles and, hence, should be taken into account in order to implement successful change. A divide and conquer' strategy with respect to the private interests appears to be effective in bringing about legislative reform. The concluding section draws tentative lessons from the political economy approaches about how to increase the likelihood of welfare-enhancing regulatory change.

Historical patterns and recent changes in the relationship between bank holding company size and risk

What is the relationship between a bank holding company's size and the risk it takes? The authors find that although the level of risk at large and small bank holding companies has not differed significantly, important distinctions exist in the nature of that risk. Historically, large companies' diversification advantages were offset by lower capital ratios and the pursuit of risk-enhancing activities. More recently, however, differences between the capital ratios and activities of large and small companies have narrowed. As a result, an inverse relationship between risk and bank holding company size has begun to emerge.Bank capital ; Bank holding companies ; Bank size

What Will Technology Do to Financial Structure?

This paper looks at how advances in information and telecommunications technologies have been changing the structure of the financial system by lowering transaction costs and reducing asymmetric information. Households and smaller businesses can now raise funds in securities markets as financial institutions have become better at unbundling risks while financial products can be distributed more efficiently through electronic networks. These changes have reduced the role of traditional financial intermediaries overall efficiency by lowering the costs of financial contracting. Despite these benefits technological progress presents policymakers with some important challenges. First markets for financial products become larger and more contestable, defining geographic and product markets narrowly becomes more problematic. Second, financial consolidation and the trend towards new activities of financial intermediaries require the exploration of new methods to preserve the safety and soundness of the financial system. A combined system of vigilant supervision and constructive ambiguity to deal with failures of larger institutions should be capable of mitigating the potential for increased risk-taking and help preserve the health of the financial system.

Throwing Good Money after Bad? Board Connections and Conflicts in Bank Lending

This paper investigates the frequency of connections between banks and non-financial firms through board linkages and whether those connections affect lending and borrowing behavior. Although a board linkages may reduce the costs of information flows between the lender and borrower, a board linkage may generate pressure for special treatment of a borrower not normally justifiable on economic grounds. To address this issue, we first document that banks are heavily involved in the corporate governance network through frequent board linkages. Banks tend to have larger boards with a higher proportion of outside directors than non-financial firms, and bank officer-directors tend to have more external board directorships than executives of non-financial firms. We then show that low-information cost firms – large firms with a high proportion of tangible assets and relatively stable stock returns -- are most likely to have board connections to banks. These same low-information cost firms are also more likely to borrow from their connected bank, and when they do so the terms of the loan appear similar to loans to unconnected firms. In contrast to studies of Mexico, Russia and Asia where connections have been misused, our results suggest that avoidance of potential conflicts of interest explains both the allocation and behavior of bankers in the U.S. corporate governance system.

Bankers on Boards: Monitoring, Conflicts of Interest, and Lender Liability

This paper investigates what factors determine whether a commercial banker is on the board of a non-financial firm. We consider the tradeoff between the benefits of direct bank monitoring to the firm and the costs of active bank involvement in firm management. Given the different payoff structures to debt and equity, lenders and shareholders may have conflicting interests in running the firm. In addition, the U.S. legal doctrines of 'equitable subordination' and 'lender liability' could generate high costs for banks which have a representative on the board of a client firm that experiences financial distress. Consistent with high potential costs of active bank involvement, we find that bankers tend to be represented on the boards of large stable firms with high proportions of tangible ('collateralizable') assets and low reliance on short-term financing. The protection of shareholder versus creditor rights under the U.S. bankruptcy doctrines may reduce the role that banks play in corporate governance and the management of financial distress, in contrast to Germany and Japan. We conclude with implications for the current bank regulatory reform debate, such as whether to permit banks to own equity in non-financial firms that, in turn, could allow them to mitigate the conflict.

Banks with something to lose: the disciplinary role of franchise value

As protectors of the safety and soundness of the banking system, banking supervisors are responsible for keeping banks' risk taking in check. The authors explain that franchise value--the present value of the stream of profits that a firm is expected to earn as a going concern--makes the supervisor's job easier by reducing banks' incentives to take risks. The authors explore the relationship between franchise value and risk taking from 1986 to 1994 using both balance-sheet data and stock returns. They find that banks with high franchise value operate more safely than those with low franchise value. In particular, high-franchise-value banks hold more capital and take on less portfolio risk, primarily by diversifying their lending activities.Bank holding companies ; Bank management ; Retail trade

The changing landscape of the financial services industry: what lies ahead?

Financial services industry ; Bank mergers

Implementation issues in chemistry and transport models

International audienceOffline chemistry and transport models (CTMs) are versatile tools for studying composition and climate issues requiring multi-decadal simulations. They are computationally fast compared to coupled chemistry climate models, making them well-suited for integrating sensitivity experiments necessary for understanding model performance and interpreting results. The archived meteorological fields used by CTMs can be implemented with lower horizontal or vertical resolution than the original meteorological fields in order to shorten integration time, but the effects of these shortcuts on transport processes must be understood if the CTM is to have credibility. In this paper we present a series of CTM experiments, each differing from another by a single feature of the implementation. Transport effects arising from changes in resolution and model lid height are evaluated using process-oriented diagnostics that intercompare CH4, O3, and age tracer carried in the simulations. Some of the diagnostics used are derived from observations and are shown as a reality check for the model. Processes evaluated include the tropical ascent, tropical-midlatitude exchange, the poleward circulation in the upper stratosphere, and the development of the Antarctic vortex. We find that faithful representation of stratospheric transport in this CTM using Lin and Rood advection is possible with a full mesosphere, ~1 km resolution in the lower stratosphere, and relatively low vertical resolution (>4 km spacing) in the middle stratosphere and above, but lowering the lid from the upper to lower mesosphere leads to less realistic constituent distributions in the upper stratosphere. Ultimately, this affects the polar lower stratosphere, but the effects are greater for the Antarctic than the Arctic. The fidelity of lower stratospheric transport requires realistic tropical and high latitude mixing barriers which are produced at 2°×2.5°, but not lower resolution. At 2°×2.5° resolution, the CTM produces a vortex capable of isolating perturbed chemistry (e.g. high Cly and low NOy) required for simulating polar ozone loss