Essays in banking
This dissertation (consisting of two essays) analyzes the impact of policy measures used to control the risk-taking behavior of banks. Specifically, the first essay explores the impact of increasing the required minimum capital to asset ratios on the riskiness of banks' assets. The second essay deals with the development of a risk-based deposit insurance model in consonance with the bailout policy of Federal Deposit Insurance Corporation (FDIC).
Increasing the prescribed minimum equity to assets ratio (capital requirement) has been proposed as an alternative for mitigating the problems created by the current fixed deposit insurance scheme. The impact of such a policy on the risk preferences of a banks' shareholders has been vigorously debated. Would the banks' shareholders respond to an increase in the capital requirement by allowing the riskiness of the banks' asset portfolios to decline or would they react by increasing the risk level of the composition in an attempt to maintain the same or similar level of expected rate of return? This study attempts to resolve this issue by empirically examining the impact of the Basle Accord (which proposes risk-based capital requirements). Empirical results indicate banks' preference for risk are likely to be increased.
The second essay focuses on the reform of the current fixed deposit insurance scheme. A theoretical model for estimating the bank insuring agency's liability and hence the risk-adjusted deposit insurance premium of a bank is derived. The model utilized here is an application of the Flexible Writer Extendible Put Option. In contrast to previous studies, the model applied here explicitly incorporates the FDIC's bailout policy (characterized by the lack of inclination on the part of FDIC to close low or negative net worth depository institutions). This distinction is significant as regulatory forbearance was originally a significant contributor to deposit insurance fund losses.
0511: Economic theory