Bank Leverage and Social Welfare
Lawrence Christiano, Daisuke Ikeda
American Economic Review · 2016 · Volume 106 · Issue 5
Abstract
We describe a general equilibrium model in which an agency problem arises because bankers must exert an unobserved and costly effort to perform their task. Suppose aggregate banker net worth is too low to insulate creditors from bad outcomes on their balance sheet. Then, banks borrow too much in equilibrium because there is a pecuniary externality associated with bank borrowing. Social welfare is increased by imposing a binding leverage restriction on banks. We formalize this argument and provide a numerical example.
Keywords
Banks, Depository Institutions, Micro Finance Institutions, Mortgages, Financial Institutions and Services: Government Policy and Regulation, Financing Policy, Financial Risk and Risk Management, Capital and Ownership Structure, Value of Firms, Goodwill, Corporate Finance and Governance: Government Policy and Regulation
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