Theoretical essays on bank risk-taking and financial stability

Chan, Ka Kei (2012). Theoretical essays on bank risk-taking and financial stability. (Unpublished Doctoral thesis, City University London)

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Abstract

This thesis proposes theoretical models to study bank risk-taking and financial stability. Three issues are explored: (1) the moral-hazard incentive for securitisation, (2) the socially optimal banking structure for the economy, and (3) the relationship between bank competition and financial stability, based on bank funding structures and fire-sale risks.

Chapter 2 proposes a model to study how bank securitisation affects the value of bank equity, and hence what leads a bank to securitise its assets. The proposed model shows that moral hazard (which is induced by the deposit insurance scheme), can be one essential motive for the securitisation of deposit-taking commercial banks. This chapter also discusses some factors that can restrain the moral-hazard and risk-taking behaviour in bank securitisation.

Chapter 3 investigates the social value of different banking structures. The proposed model finds that total separation is not the optimal banking structure for an economy, because it forbids the liquidity transfer between subsidiary banks, which is socially valuable. The comparison between ring-fencing and universal banking is more complicated; Chapter 3 shows that whether ring-fencing or universal banking is the best banking structure for an economy depends on the returns to the different subsidiary banking sectors.

Chapter 4 studies how asset fire-sales risks and bank funding structures can affect the relationship between bank competition and financial stability. The proposed model finds that the funding-structure risks of the banks can create an incentive for excess risk-taking in a multi-bank economy. Moreover, the model shows that the excessive risk taking increases with the number of banks in the economy. This result is similar in spirit to the Cournot equilibrium in standard microeconomic theory.

Item Type: Thesis (Doctoral)
Subjects: H Social Sciences > HG Finance
Divisions: Cass Business School > Faculty of Finance
City University London PhD theses
URI: http://openaccess.city.ac.uk/id/eprint/1966

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