Accounting and Finance Seminar - Sonny Biswas (University of Bristol)
G.15, 15-19 Tyndalls Park Road
Bank capital structure and regulation under adverse selection: An optimal contracting framework
In a model with heterogeneously skilled agents we show that, i. skilled agents hold capital and the unskilled deposit, ii. bank capital is costly since the skilled have a higher outside option and iii. in presence of adverse selection, banks use deposit rates to signal type; lifting deposit rate ceilings may lead to consolidation in the banking sector, as is observed empirically. The skilled banker may divert some output; offering a deposit contract to the unskilled and becoming the residual claimant relaxes the constraint, allowing bank formation. In the presence of adverse selection, both a capital requirement and a floor on the deposit rate may achieve constrained efficiency, but the deposit floor is the superior tool.