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Moral Hazard under Commercial and Universal Banking

John H. Boyd, Chun Chang and Bruce D. Smith
Journal of Money, Credit and Banking
Vol. 30, No. 3, Part 2: Comparative Financial Systems (Aug., 1998), pp. 426-468
DOI: 10.2307/2601249
Stable URL: http://www.jstor.org/stable/2601249
Page Count: 43
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Moral Hazard under Commercial and Universal Banking
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Abstract

Many claims have been made about the potential benefits and the potential costs of adopting a system of universal banking in the United States. We evaluate these claims using a model where there is a moral hazard problem between banks and "borrowers," a moral hazard problem between banks and a deposit insurer, and a costly state verification problem. Under conditions we describe, allowing banks to take equity positions in firms strengthens their ability to extract surplus, and exacerbates problems of moral hazard. The incentives of universal banks to take equity positions will often be strongest when these problems are most severe.

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