Frederick T. Furlong

Capital regulation and bank risk-taking: A note

Abstract This paper examines theoretically the effects of more stringent capital regulation on bank asset portfolio risk. The analysis shows that, for a value-maximizing bank, incentives to increase asset risk decline as its capital increases. Thus, as long as regulatory efforts to contain asset risk and size are not reduced, more stringent capital regulation unambiguously reduces the expected liability of the deposit insurance system.

A reexamination of mean-variance analysis of bank capital regulation

Abstract The mean-variance framework has been used to analyze the effects of bank capital regulation on the asset and bankruptcy risk of insured, utility-maximizing banks. This literature claims that more stringent capital regulation will increase asset risk and can increase bankruptcy risk. These conclusions are notable because they are opposite to those obtained for insured, value-maximizing banks. In this paper, we show that the utility-maximization literature does not support its conclusions regarding the effects of bank capital regulation because it has mischaracterized the banks investment opportunity set by neglecting the option value of deposit insurance.

Safe and Sound Banking, 20 Years Later: What was Proposed and What has Been Adopted

In 1986, a task force of banking academics organized and sponsored by the American Bankers Association convened to examine the banking industry and the efficacy of its regulatory system. The group was charged with reviewing the problems of ensuring the safety and soundness of the banking system and evaluating a number of policy options to improve the efficiency, performance, and safety of the system by changing the structure of the deposit insurance system and the bank regulatory and supervisory process. The results of the work of the task force were published by the MIT Press as the book, Perspectives on Safe and Sound Banking (Benston et al., 1986, the Report), which includes a set of principal options and recommendations. The purpose of this article is to assess the extent to which changes in public policy regarding depository institutions have been aligned with the recommendations of the Report. We find that, over the past 20 years, several legislative initiatives and changes in regulations and the bank supervisory process have been in keeping with the specific recommendations of the Report or with the analytic framework underlying the recommendations. At the same time, other recommendations in the Report have not been taken up and some proposals rejected in the Report have been put in place by legislative and regulatory initiatives. Overall, public policy and private sector initiatives appear to have contributed to safer and sounder banking and thrift sectors over the past 20 years. Consistent with what we see as the main theme of the Report, a likely contributing factor is the more appropriate alignment of incentive for risk-taking among larger depository institutions. Developments affecting risk-taking by depository institutions likely include higher capitalizations, greater risk exposure of private sector stakeholders more generally, improvements in risk management, and supervision and regulation that is focused on overall risk.

Financial Modernization and Regulation

Financial systems worldwide have been marked by a push toward financial moderization and rolling financial crises over the past several years. These developments have put pressure on financial supervision and regulation to adapt. While some changes in regulatory overnight have taken place, adaptation of financial supervision and regulation can be expected to continue into the 21st century.

Mortgage Choice: Interactive Effects of House Price Appreciation and Mortgage Pricing Components

Previous research provides rationales for and evidence of a link between house price appreciation and mortgage choice, with higher appreciation associated with higher take-up rates for adjustable-rate mortgages relative to fixed-rate mortgages. Research also finds mortgage interest rates and their underlying components to be important determinants of mortgage financing choices. In this paper we extend the earlier research and show that house price appreciation can have important interactive effects with those other determinants of mortgage financing choices. The analysis focuses on the period from 2000 to 2007, an episode marked by rapid house price appreciation along with a persistent and notable increase in the use of adjustable-rate mortgage financing, including alternative mortgage products. We find that higher house price appreciation dampened the estimated sensitivity of take-up rates among mortgage financing options to the underlying mortgage pricing components. The results, which are especially robust for fixed-rate and adjustable-rate mortgages that are fully amortized, were not driven solely by observations in markets with especially high rates of house price appreciation. Moreover, after taking into account the interactive effects with mortgage pricing components, house price appreciation is estimated to have had relatively little additional effect on take-up rates among mortgage financing options.