Expansion of Commercial Banking Powers
Journal of Banking & Finance 23 (1999) 655±662
Expansion of commercial banking powers F F F or, universal banking is the cart, not the horse
John H. Boyd
*
Carlson School of Management, University of Minnesota, 271-19th Avenue, Minneapolis, MN 55455, USA
Abstract This short essay deals with universal banking in an environment in which a government safety net (for example deposit insurance) results in a moral hazard problem for banks. It argues that universal banking signi®cantly exacerbates the problem. Speci®cally, universal banking extends the distortion of incentives caused by moral hazard to other sectors of the economy. Ó 1999 Elsevier Science B.V. All rights reserved. JEL classi®cation: G21 Keywords: Universal banking; Commercial banking; Bank regulation
1. Introduction The title of my essay is a paraphrase of the title of an earlier paper by my colleague, and dear friend, Jack Kareken. His much cited paper (Kareken, 1983) is rather famous because it essentially predicted the savings and loan crisis. Unfortunately, it was not so widely read in the early eighties. Whereas I am not predicting any impending crisis, I am making the same logical point as
Corresponding author. Corresponding address: Kappell chair in Business and Government, Finance Department, Carlson School, Room 3-110, 321 19th Avenue South, Minneapolis, MN 55455, USA; e-mail: jboyd@csom.umn.edu. 0378-4266/99/$ ± see front matter Ó 1999 Elsevier Science B.V. All rights reserved. PII: S 0 3 7 8 - 4 2 6 6 ( 9 8 ) 0 0 1 0 1 - 0
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656
J.H. Boyd / Journal of Banking & Finance 23 (1999) 655±662
Kareken regarding the importance of sequence. In this essay, universal banking is the ``cart ' ', and reform of the bank safety net (deposit insurance, the Discount Window, etc.) is the ``horse ' '. My punch line is this: if a universal banking system is implemented in the US without, ®rst, eliminating moral hazard due to the safety net, the consequences could be most undesirable. Since,
Expansion of commercial banking powers F F F or, universal banking is the cart, not the horse
John H. Boyd
*
Carlson School of Management, University of Minnesota, 271-19th Avenue, Minneapolis, MN 55455, USA
Abstract This short essay deals with universal banking in an environment in which a government safety net (for example deposit insurance) results in a moral hazard problem for banks. It argues that universal banking signi®cantly exacerbates the problem. Speci®cally, universal banking extends the distortion of incentives caused by moral hazard to other sectors of the economy. Ó 1999 Elsevier Science B.V. All rights reserved. JEL classi®cation: G21 Keywords: Universal banking; Commercial banking; Bank regulation
1. Introduction The title of my essay is a paraphrase of the title of an earlier paper by my colleague, and dear friend, Jack Kareken. His much cited paper (Kareken, 1983) is rather famous because it essentially predicted the savings and loan crisis. Unfortunately, it was not so widely read in the early eighties. Whereas I am not predicting any impending crisis, I am making the same logical point as
Corresponding author. Corresponding address: Kappell chair in Business and Government, Finance Department, Carlson School, Room 3-110, 321 19th Avenue South, Minneapolis, MN 55455, USA; e-mail: jboyd@csom.umn.edu. 0378-4266/99/$ ± see front matter Ó 1999 Elsevier Science B.V. All rights reserved. PII: S 0 3 7 8 - 4 2 6 6 ( 9 8 ) 0 0 1 0 1 - 0
*
656
J.H. Boyd / Journal of Banking & Finance 23 (1999) 655±662
Kareken regarding the importance of sequence. In this essay, universal banking is the ``cart ' ', and reform of the bank safety net (deposit insurance, the Discount Window, etc.) is the ``horse ' '. My punch line is this: if a universal banking system is implemented in the US without, ®rst, eliminating moral hazard due to the safety net, the consequences could be most undesirable. Since,
References: American Banker, 1997. Criticism of Financial Reform Overblow, Shadow Panel Says, May 6. Benveniste, L., Boyd, J.H., Greenbaum, S., 1991. Bank capital regulation. Osaka Economic Papers. Boyd, J.H., Chang, C., Smith, B., Moral hazard under commercial and universal banking. Journal of Money, Credit and Banking, forthcoming. Gorton, G., Schmid, F.A., 1996. Universal Banking and the Performance of German Firms. Working Paper, University of Pennsylvania, Philadelphia, PA. Kareken, J., 1983. Deposit insurance reform or deregulation is the cart, not the horse. Minneapolis Federal Reserve Bank Quarterly Review 7, 1±9. Kareken, J., Wallace, N., 1978. Deposit insurance and bank regulation: A partial equilibrium exposition. Journal of Business 51, 413±438. Keeley, M., 1990. Deposit insurance, risk and market power in banking. American Economic Review 80 (5), 1183±1200. Merton, R.C., 1977. An analytical derivation of the cost of deposit insurance and loan guarantees: An application of modern option pricing theory. Journal of Business and Finance 1, 3±11. Saunders, A., Walter, I., 1994. Universal Banking in the US. Oxford University Press, New York. US Treasury, 1991. Modernizing The Financial System: Recommendations for Safer, More Competitive Banks. Department of the Treasury, Washington, DC.