Financial Opacity and Bank’s Asset Portfolio Strategy

Monday, February 11, 2013 ( 2:00 pm to 3:00 pm )

Location: Babbio 104

Financial Opacity and Bank’s Asset Portfolio Strategy

 

Zhao Yang, University of Pennsylvania

 

ABSTRACT

This paper studies the optimal contract and portfolio decisions of banks in an opaque banking system where consumers have limited information about each bank's asset portfolio and its ability to repay debt.

This paper is able to explain the bank asset portfolio heterogeneity observed in the 2007-2009 financial crisis, in which some banks incurred large losses from risky assets while other banks had abundant liquidity and made profitable purchases and acquisitions. In this banking system, inefficient risk-taking is undetectable by consumers until a bank incurs losses. Upon learning about such losses, consumers make a run on the affected bank, which becomes bankrupt and begins to liquidate assets. In equilibrium, as banks are leveraged, risk-taking and potential bankruptcies of a small number of banks are generally unavoidable. However, these bankruptcies indirectly prevent more banks from engaging in risk-taking. Because healthy banks can profit from the asset sales and liquidations of risk-taking banks, an increasing number of bankruptcies will allow healthy banks to offer more favorable contracts to consumers, making further risk-taking less attractive. Therefore the banking sector is endogenously divided into risk-taking and healthy banks. The banking model I develop has an optimal level of capital requirement. A capital requirement that is too high or too low is not optimal for consumer welfare.

 

BIOGRAPHY

Zhao Yang is a PhD candidate in Economics at the University of Pennsylvania. Zhao attended undergraduate studies at the University of Toronto in Canada. His research focuses on financial markets and macroeconomics. In particular, he is interested in studying the impact of financial intermediaries and financial markets on the macro economy, as well as the impact of government policies on the financial markets.