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Competition, coinsurance and moral hazard in banking

Author

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  • Hasman, Augusto
  • Samartín, Margarita

Abstract

This study examines the interaction between bank deposit market competition, incentives to take risks on the asset side, and willingness to participate in the interbank market for liquidity coinsurance. The interbank market in the model has two countervailing effects on risk-taking. First, it allows for more profitable long-term investment, which adds to a bank’s charter value and decreases risk-taking motives. Second, greater investment in the long-term asset also makes risk-taking potentially more profitable, thus eroding charter value. Finally, risk-taking motives also influence banks’ decisions to participate in the interbank market. We demonstrate how a combination of capital requirements and posting a surety bond can restore charter value, promote cooperation and boost economic activity. Additionally, this measure does not limit competition in generating charter value and implies lower costs than capital requirements alone.

Suggested Citation

  • Hasman, Augusto & Samartín, Margarita, 2024. "Competition, coinsurance and moral hazard in banking," Journal of Banking & Finance, Elsevier, vol. 164(C).
  • Handle: RePEc:eee:jbfina:v:164:y:2024:i:c:s0378426624001249
    DOI: 10.1016/j.jbankfin.2024.107207
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    References listed on IDEAS

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    More about this item

    Keywords

    Capital requirements; Charter value; Interbank market; Liquidity coinsurance; Moral hazard;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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