Browsing by Subject "Banking"

I study local shocks to consumer credit supply arising from the opening

of bank-related retail stores. Bank-related store openings coincide with

sharp increases in credit card placements in the neighborhood of the

store, in the months surrounding the store opening, and with the bank

that owns the store. I exploit this relationship to instrument for new

credit cards at the individual level, and find that obtaining a new

credit card sharply increases total borrowing as well as default risk,

particularly for risky and opaque borrowers. In line with theories of

default externality, I observe that existing lenders react to the

increased consumer borrowing and associated riskiness by contracting

their own supply. In particular, in the year following the issuance of a

new credit card, banks without links to stores reduce credit card limits

by 24-51%, offsetting most of the initial increase in total credit

limits.

Bank stress test has become a centerpiece of post crisis bank supervision. Current studies have thus far examined the optimal policies on stand-alone single banks, but financial systems are interconnected in practice, and disclosure about banks influences the counterparty risks of other banks. This dissertation studies the optimal stress test design in a financial network, where banks' endogenous default outcomes are determined by a fixed point payment problem that accounts for both project qualities and interbank contagion.

The first part examines the joint stress test design on all banks in the financial network. In addition to the cross-state risk sharing in models of single banks, this model highlights the novel cross-bank risk sharing that arises from the spillover effects of disclosures via interbank payments. When expected bank profitability is high or counterparty exposures are large, disclosure is non-discriminatory, and either all banks pass or all banks fail the stress tests; otherwise only less impaired banks may pass. For network structures, I find: (i) in a ring network, banks at least a specific distance away from the nearest bank with asset impairment may pass; (ii) a more connected network is not necessarily more stable under the optimal disclosure; (iii) typically more connected banks receive preferred treatment.

The second part studies a selective stress test in a financial network, where the regulator selects an optimal subset of banks for stress tests and accordingly design the optimal disclosures only on these banks. Compared with the first part, systemic risk becomes more important as the regulator is less able to fine tune beliefs about contagion and needs to contain the risks from unselected banks. For network structures, I find: (i) in a ring network, stress test is either "balanced'' on banks positioned evenly and disclosure is non-discriminatory, or on "connected'' banks and disclosure is truth-telling on potential shocks; (ii) in a star network, stress test is conducted on the center bank when counterparty exposure is either sufficiently small or sufficiently large.

My dissertation seeks to understand how and why governments make major changes in financial sector regulations. I focus on two specific puzzles. First why is financial sector regulation not normally central to electoral competition and why are changes in financial sector regulation rare events? Second, why do we observe substantive intellectual debates and efforts of policy persuasion despite the conclusion of many researchers and observers that financial regulatory policy outcomes are driven by the preferences of powerful special interest groups? What are the mechanisms precisely by which ideas versus interests shape policy outcomes in a domain that is not often central to electoral politics? I investigate these questions through a formal game theoretical model of the regulatory policymaking process and through case studies of historic episodes of financial regulatory change in the United States which draw upon a wide variety of primary and secondary source historical materials. I conclude that financial regulatory change is most likely to occur when events of different types cause heads of government to perceive that the existing regulatory status quo threatens the realization of broader policy objectives. Heads of financial sector policy bureaucracies shape outcomes by providing cognitive frameworks through which leaders understand regulatory consequences. Interest groups influence policy outcomes primarily through their ability to act as veto players rather than by controlling the policy agenda.

In my first chapter, I present a model in which sellers can signal the quality of an asset both by retaining a fraction of the asset and by choosing the liquidity of the market in which they search for buyers. Although these signals may seem interchangeable, I present two settings which show they are not. In the first setting, sellers have private information regarding only asset quality, and I show that liquidity dominates retention as a signal in equilibrium. In the second setting, both asset quality and seller impatience are privately known, and I show that both retention and liquidity operate simultaneously to fully separate the two dimensions of private information. Contrary to received theory, the fully separating equilibrium of the second setting may contain regions where market liquidity is increasing in asset quality. Finally, I show that if sellers design an asset-backed security before receiving private information regarding its quality, then the optimality of standard debt is robust to the paper's various settings.

In my second chapter, I explore the question of how informative bank stress tests should be. I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks' capital cushions. I also examine the impact of anticipated stress tests on banks' ex ante incentive to invest in risky versus safe assets.