Essays on the regulation of financial institutions

This dissertation investigates the theory of banking "safety nets," comprising the central bank's discount window and deposit insurance. Evidence is also examined to test whether the American banking crisis of the 1980s and 1990s was primarily due to distress in the "real economy" or increased risk-taking by banks.; In the first essay, I develop a theoretical model in which demandable debt keeps the incentives of bankers and depositors aligned. Demandability creates bank runs, however, which cause real damage to the economy. I show that private deposit insurance and last-resort lending, each provided by a single firm, may reduce expected deadweight losses. These "safety-net" institutions serve depositors as delegated monitors of banks. Deposit insurance and a lender of last resort are welfare-enhancing in a risk-neutral world only if the economy is large enough.; The second essay shows that "small" banking systems benefit from a mutual guaranty of deposits. Deposit insurance, on the other hand, requires many banks, since the ability of a deposit insurer to diversify varies directly with the number of banks in the economy. A survey of actual practice around the developed world supports this chapter's predictions.; The third essay investigates two explanations for the recent rise in bank failures. The increased risk-taking hypothesis contends that increased competition, due in part to financial deregulation, reduced banks' market power in lending and deposit markets--and hence, charter value--, encouraging banks to exploit fixed-price deposit insurance more fully by taking greater risks. A larger number of failures than before should result. The local economic-conditions hypothesis, on the other hand, asserts that increased bank failures in the U.S. arose primarily because of shocks to specific economic sectors and geographic regions. Using a fixed-effects Tobit model on a panel-data set covering all 50 states plus D.C. over the period 1970-'91, I find that increased risk-taking alone cannot explain the timing and location of bank failures. Poor local economic conditions are an independent source of banking distress. Bank failure are most likely when increased risk-taking co-incides with a bad local economy.