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Banking Regulation without Commitment to Audit


Leoni, Patrick (2005). Banking Regulation without Commitment to Audit. Working paper series / Institute for Empirical Research in Economics No. 251, University of Zurich.

Abstract

We consider a regulator providing deposit insurance to a bank with private information about its investment portfolio. As typical in practice, we assume that the regulator does not commit to auditing afternany risk report from the bank. We first show that the optimal contract can be implemented through a direct revelation mechanism. We also show that, at the optimal contract, a high risk bank has incentivesnto misreport. We thus establish that extraction of truthful riskninformation, as done in current regulatory practice, is not compatible with the maximization of social welfare.

Abstract

We consider a regulator providing deposit insurance to a bank with private information about its investment portfolio. As typical in practice, we assume that the regulator does not commit to auditing afternany risk report from the bank. We first show that the optimal contract can be implemented through a direct revelation mechanism. We also show that, at the optimal contract, a high risk bank has incentivesnto misreport. We thus establish that extraction of truthful riskninformation, as done in current regulatory practice, is not compatible with the maximization of social welfare.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Institute for Empirical Research in Economics (former)
Dewey Decimal Classification:330 Economics
Language:English
Date:August 2005
Deposited On:29 Nov 2011 22:32
Last Modified:05 Apr 2017 23:13
Series Name:Working paper series / Institute for Empirical Research in Economics
ISSN:1424-0459
Official URL:http://www.econ.uzh.ch/wp.html

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