We analyse a variant of the Diamond-Dybvig (1983) model of banking in which savers can use a bank to invest in a risky project operated by an entrepreneur. The savers can buy equity in the bank and save via deposits. The bank chooses to invest in a safe asset or to fund the entrepreneur. The bank and the entrepreneur face limited liability and there is a probability of a run, which is governed by the bank’s leverage and its mix of safe and risky assets. The possibility of the run reduces the incentive to lend and take risk, while limited liability pushes for excessive lending and risk-taking. We explore how capital regulation, liquidity regulation, deposit insurance, and loan to value limits interact to offset these frictions. We compare agents’ welfare in the decentralised equilibrium absent regulation with welfare in equilibria that prevail with various regulations that are optimally chosen. In general, regulation can replicate the allocations chosen by a planner, but doing so requires more than one regulation.
Anil Kashyap’s research focuses on financial intermediation and regulation, the Japanese economy, price setting, and monetary policy. His research has won him numerous awards, including a Sloan Research Fellowship, the Nikkei Prize for Excellent Books in Economic Sciences, and a Senior Houblon-Norman Fellowship from the Bank of England (twice). As of 1 October 2016 he is an external member of the Bank of England’s Financial Policy Committee.
Prior to joining the Chicago Booth faculty in 1991, Professor Kashyap spent three years as an economist for the Board of Governors for the Federal Reserve System. He currently works as a consultant for the Federal Reserve Bank of Chicago and as a research associate for the National Bureau of Economic Research (NBER). He serves on the Board of Directors of the Bank of Italy’s Einaudi Institute of Economics and Finance, is a member of the Squam Lake Group and serves on the International Monetary Fund’s Advisory Group on the development of a macro-prudential policy framework.
Professor Kashyap is also one of the academic members of the Bellagio Group (whose non-academic members consist of the Deputy Central Bank Governors and Vice Ministers of Finance of the G7 countries). This experience, along with his research and other consulting and advising to central banks and finance ministries around the world, has helped him create his two unique elective courses, “Understanding Central Banks” and “The Analytics of Financial Crises.”
Professor Kashyap is a member of both the American Economic Association (AEA) and American Finance Association, and is on the faculty oversight board of the Chicago Booth’s Initiative on Global Markets and a co-founder of the US Monetary Policy Forum. He regularly speaks on the financial crisis, Japan, the global economy, and the direction of economic policy.
This seminar is organised in association with the Cambridge Corporate Governance Network (CCGN).