Contemporary Banking Theory

Capital markets, financial intermediaries, and liquidity supply

“…asymmetric information) that are not explicitly considered in our paper (for a review of this literature, see Bhattacharya and Thakor (1993)). Furthermore, the restrictions on asset trading needed to implement some of the intermediary equilibria may not be compatible with a fully competitive, pro®t-maximizing ®nancial intermediary sector.…”

Universal banking, asymmetric information and the stock market

“…If the signal is low, it means that banks get early information that most of the projects will turn out to be a lemon with a negligible value m (close to zero). 9 At t = 2, uncertainties get resolved and all agents receive pay-o¤ according to the contracts written at date t = 1, which, in turn, depends on (a) resolution of individual uncertainty and the rest. On the other hand, no such law holds for a low aggregate state.…”

“…8 Under universal banking, banks or intermediaries can hold securities which are otherwise unrestricted and tradable compared with the system where banks can only hold debt securities which cannot easily be traded in the …nancial/debt market. 9 The rationale behind such assumption is that since banks lend and monitor a large number of projects across the economy, they gather expertise to collect information relevant not only to a single project but can extract information about the overall economy better than the households. This is a standard function of banks who are also known as "informed lenders" (see Freixas and Rochet, 2008).…”

“…However, in equilibrium these two average variables are determined by aggregate consistency conditions. Equation (9) shows that when the bank receives a bad news (state l) about the economy, the project is liquidated and the banks receive the liquidation value as it has the …rst priority over claims. Recall that in such a low signal state (which is a state of macroeconomic shock), banks are unable to make full payment and only return the deposits s to the households.…”

“…The model in this sense builds on Azariadis (1993, page 238-244), Bhattacharya and Thakor (1993) and Diamond (1984) and Gurley and Shaw (1960). We embed optimal …nancial contracts into this traditional model of banking where banks hold both deposits and tradable …nancial securities of their client …rms.…”