Private Liquidity and Banking Regulation

45 Pages Posted: 15 May 2012

See all articles by Cyril Monnet

Cyril Monnet

University of Bern

Daniel R. Sanches

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Date Written: May 2012

Abstract

We show that the regulation of bank lending practices is necessary for the optimal provision of private liquidity. In an environment in which bankers cannot commit to repay their creditors, we show that neither an unregulated banking system nor narrow banking can provide the socially efficient amount of liquidity. If the bankers provided such an amount, then they would prefer to default on their liabilities. We show that a regulation that increases the value of the banking sector’s assets (e.g., by limiting competition in bank lending) will mitigate the commitment problem. If the value of the bank charter is made sufficiently large, then it is possible to implement an efficient allocation. Thus, the creation of a valuable bank charter is necessary for efficiency.

Keywords: Private liquidity creation, banking regulation, limited commitment

JEL Classification: E40, E42, G21, G28

Suggested Citation

Monnet, Cyril and Sanches, Daniel R., Private Liquidity and Banking Regulation (May 2012). FRB of Philadelphia Working Paper No. 12-11, Available at SSRN: https://ssrn.com/abstract=2060406 or http://dx.doi.org/10.2139/ssrn.2060406

Cyril Monnet (Contact Author)

University of Bern ( email )

Gesellschaftsstrasse 49
Bern, BERN 3001
Switzerland

Daniel R. Sanches

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

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