sunandaC

New member
SPECIAL PROBLEMS OF BANKS

The discussion so far has focused on a general overview of corporate governance. We now turn to the specific problems of banks and attempt to address why the scope of the duties and obligations of corporate officers and directors should be expanded in the case of banks.


Our argument is that the special corporate governance problems of banks weaken the case for making shareholders the exclusive beneficiaries of fiduciary duties. Our focus here is on establishing why banks are not like other firms and thus why they should be treated differently.

The Liquidity Production Role of Banks


Many different types of firms extend credit. Similarly, a variety of nonbank firms, most notably money market mutual funds and nonbank credit card companies, offer the equivalent of a check transaction account. What distinguishes banks from other firms is their capital structure, which is unique in two ways. First, banks tend to have very little equity relative to other


firms. Although it is not uncommon for typical manufacturing firms to finance themselves with more equity than debt, banks typically receive 90 percent or more of their funding from debt.

Second, banks’ liabilities are largely in the form of deposits, which are available to their creditors/depositors on demand, while their assets often take the form of loans that have longer maturities (although increasingly refined secondary markets have mitigated to some extent the mismatch in the term structure of banks’ assets and liabilities).


Thus, the principal attribute that makes banks as financial intermediaries “special” is their liquidity production function. By holding illiquid assets and issuing liquid liabilities, banks create liquidity for the economy.


The liquidity production function may cause a collective action problem among depositors because banks keep only a fraction of deposits on reserve at any one time. Depositors cannot obtain repayment of their deposits simultaneously because the bank will not have sufficient funds on hand to satisfy all depositors at once.


This mismatch between deposits and liabilities becomes a problem in the unusual situation of a bank run. Bank runs are essentially a collective-action problem among depositors.


If, for any reason, large, unanticipated withdrawals do begin at a bank, depositors as individuals may rationally conclude that they must do the same to avoid being left with nothing.


Thus, in a classic prisoner’s dilemma, depositors may collectively be better off if they refrain from withdrawing their money, but their inability to coordinate their response to the problem can lead to a seemingly irrational response—depositors rush to be among the first to withdraw their funds so that they can obtain their money before the bank’s cash reserves are drained.


Critical to this analysis is the fact that failures can occur even in solvent banks.


Thus, one argument used to justify special regulatory treatment of banks is that the collective-action problem among bank depositors can cause the failure of a solvent bank.


Deposit insurance is often justified on the grounds that it solves this problem by eliminating the incentive for any single depositor to rush to demand repayment of his deposits.
 
Top