Theory of Banking

Aннотация:
The course will cover different aspects of the theory of banking and financial intermediation including the following topics:

• Monitoring by and within banks

• Liquidity

• Bank runs and financial crises

• Regulation

• Financial contracting and interbank competition

• Comparative financial systems

• Credit markets and the macro environment

Audience: The course is intended for graduate students with a general interest in financial markets and institutions. Special efforts will be made to assist students in developing research topics for their dissertations.

Программа курса по теории банков, прочитанного А. Бутом и К. Фрексасом в Стокгольмской школе экономики на факультете финансов в апреле-мае 2001 года.

Theory of Banking

Contents: The course will cover different aspects of the theory of banking and financial intermediation including the following topics:

• Monitoring by and within banks

• Liquidity

• Bank runs and financial crises

• Regulation

• Financial contracting and interbank competition

• Comparative financial systems

• Credit markets and the macro environment

Audience: The course is intended for graduate students with a general interest in financial markets and institutions. Special efforts will be made to assist students in developing research topics for their dissertations.

Pre-requisites: Since much of the course material applies game and contract theoretic tools, participants are expected to be familiar with basic concepts in these areas of microeconomics. Prior attendance of the corporate finance course (finance IV) is recommended.

Literature

Textbook

Freixas, X. and Rochet, J.C., Microeconomic theory of banking. MIT Press, 1997.

1. General Introduction and Empirical Findings

References:
-Allen F., Gale D., "Financial-Markets, Intermediaries, and Intertemporal Smoothing, Journal of Political Economy, 1997; vol. 105; 3: 523-546.
-Fama, E. , "Banking in the Theory of Finance", Journal of Monetary Economics, 1980;vol. 6;1:39-57.

2. Why Do Financial Intermediaries Exist?

- Economies of scale and economies of scope
- Assets transformation
- Liquidity
- Default risk
- Maturity
- Indivisibilities
Information and monitoring
The equilibrium level of financial intermediation
Competition in the deposit and loans markets

References:
-Boot A.W., Thakor A.V., "Financial System Architecture", Review of Financial Studies", 1997; vol. 10; 3: 693-733.
-Calomiris, C. W., and C.M. Kahn, "The Role of Demandable Debt in structuring Optimal Banking Arrangements", American Economic Review, 1991;vol. 81;3: 497-513.
-Holmstrom, B., and J. Tirole, "Financial Intermediation, Loanable Funds, and the Real Sector", Quarterly Journal of Economics, 1997; vol. 112;3: 663-691.

3. The Industrial Organization Approach

The Monti-Klein model
Generalization

References:
-Boot, A. and Schmeits, A., Journal of Financial Intermediation, 2000; vol. 9, No. 3: 240-273.
-Rajan, R., "Insiders and Outsiders: The Choice between Relationship and Arm's Length Debt", Journal of Finance, 1992; vol. 47; 1: 1367-1400.
-Sharpe, S., "Assymetric Information, Bank Lending and Implicit Contracts: A Stylized Model of Customer Relationships", Journal of Finance, 1990; vol. 45; 4: 1069-87.

4. The Borrower-Lender Contract in Asymmetric Information

References:
-Berglöf E., and von Thadden E.L., " Short term versus Long Term Interests :Capital Structure with Multiple Investors" Quarterly Journal of Economics, 1994, 4, 1055-1084.
-Bolton, P., and X. Freixas, "Equity, Bonds and Bank Debt: Capital Structure and Financial Market Equilibrium under Asymmetric Information" Journal of Political Economy, April 2000, 2, 108, 324-51.
-Boot, A., S. Greenbaum, and A. Thakor, "Reputation and Discretion in Financial Contracting", The American Economic Review, 1994; vol.83; 5: 1165-83.
-Bulow, J., and Rogoff, K., "Sovereign Debt: Is to Forgive to Forget?", American Economic Review, 1989; vol. 79; 1:43-50.
-Dewatripont, M., and E. Maskin, "Credit and Efficiency in Centralized and Decentralized Economies", Review of Economics Studies, 1995; vol. 62; 4:541-56.
-Hart, O. and J.Moore, "A Theory of Debt Based on the Inalienability of Human Capital", Quarterly Journal of Economics, 1994; 109:841-79.
- Hart, O. and Moore, "Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management", American Economics Review, 1995; 85: 567-85.
-Padilla A.J., Pagano M., "Endogenous Communication among Lenders and Entrepreneurial Incentives", Review of Financial Studies, 1997; vol. 10; 1: 205-236.

5. Equilibrium and Rationning in the Credit Market

Equilibrium in the credit market
Definition and previous explanations of credit rationning
Adverse selection
- Stiglitz-Weiss
Moral hazard
- The static approach
- The dynamic approach

References:
-Besanko, D., and A. Thakor, "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets", International Economic Review, 1987;vol. 28; 3: 671-89.
-De Meza, D., and D. Webb, "Too Much Investment: A Problem of Asymmetric Information", Quarterly Journal of Economics, 1987; vol. 102(2): 281-92.
-Stiglitz, J., and A. Weiss, "Credit Rationing in Markets with Imperfect Information", American Economic Review, 1981; vol. 71;3: 393-410.
-Williamson, S., "Costly Monitoring, Loan Contracts, and Equilibrium Credit Rationing", Quarterly Journal of Economics, 1987; vol. 102; 1: 135-45.

6. Macroeconomic Consequencies of the Financial Intermediation

References:
-Bernake, B., and Gertler M., "Financial Fragility and Economic Performance", Quarterly Journal of Economics, 1990; vol. 105; 1: 87-114.
-Holmström, B., and Tirole, J., "Private and Public Supply of Liquidity", Journal of Political Economy 1998.
-Williamson, S. D., "Financial Intermediation, Business Failures, and Real Business Cycles", Journal of Political Economy, 1987; vol. 95; 6: 1196-216.

7. Individual Bank Runs and Systematic Risk

Bank runs
The role of the central bank

References:
-Bhattacharya, S. and D. Gale, "Preference Shocks, Liquidity and Central Bank Policy",1987, In New approaches in monetary economics, edited by W. Bamett and K. Singleton. Cambridge: Cambridge University Press.
-Chari, V., R. Jagannathan,. "Banking Panics, Information and Rational Expectations Equilibrium", Journal of Finance, 1988; vol. 43; 3: 749-61.
-Diamond, D. W, and R.H. Dybvig, "Bank Runs, Deposit Insurance, and Liquidity", Journal of Political Economy, 1983; vol. 91; 3: 401-19.
-Freixas, X., B. Parigi and J.C. Rochet, "Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank" Journal of Money Credit and Banking, 2000.
-Jacklin, C. J., "Demand Deposits, Trading Restrictions and Risk Sharing", 1987, in Contractual arrangements for intertemporal trade, edited by E. Prescott and N. Wallace. Minneapolis: University of Minnesota Press.

8. Managing Risk in the Banking Firm

Default risk
- Institutional context
- Evaluating the cost of default risk
- Empirical evidence (credit scoring)
- Extensions
Portfolio risk
- Modern portfolio theory
- Application to the banking firm
- The impact of capital requirements
- Banks as market makers

References:
-Hart, O., and D. Jaffee., "On the Application of Portofolio Theory of Depository Financial Intermediaries", Review of Economic Studies, 1974; vol. 41; 1: 129-47.
-Rochet, J.C., "Capital Requirements and the Behaviour of Commercial Banks", European Economic Review, 1992; vol. 36; 5: 1137-70.

9. The Regulation of Banks

References:
-Aghion, P., P. Bolton and S. Fries, ''Optimal Design of Bank Bailouts: The Case of Transition Economies'' JITE, p.51-70.
-Bhattacharya, S., A. Boot and A. Thakor, "The Economics of Bank Regulation",1995, Working paper no. 5 16, CEMFI, Madrid.
-Freixas, X. C. Giannini, G. Hoggarth and F.Soussa "Lender of Last Resort: what have we learnt since Bagehot?" Journal of Financial Services Research, 2000.
-Freixas, X. and A. Santomero (2000), ''An Overall Perspective on Banking Regulation'', unpublished manuscript, Universitat Pompeu Fabra.
-Giammarino, R. M., Lewis T. R., and Sappington D., "An Incentive Approach to Banking Regulation", The Journal of Finance, 1993; 48: 1523-42.
-Matutes, C., and Vives X., "Imperfect Competition, Risk Taking, and Regulation in Banking", European Economic Review.

Due to copyright laws, copies of the reading material cannot be handed out. Instead papers can be found in the "Library of the Finance Department'', room 666. You can borrow a paper, copy it promptly and return it. (In addition, Marita Rosing has a complete set of the reading material, in case a paper mysteriously disappears.)

Teaching

Lectures will be given by Xavier Freixas, Universitat Pompeu Fabra and by Arnoud Boot, University of Amsterdam.

Exam

Written exam or term paper.