Resource information
In absence of deposit insurance,
underdeveloped financial systems can exhibit a coordination
failure between banks, unable to commit on safe asset
holding, and depositors, anticipating low deposit repayment
in bad states. This paper shows conditions under which a
government can solve this failure by imposing safe asset
purchases, which boosts deposits by increasing depositor
repayment in bad states. In so doing, financial regulation
stimulates bank profits if subsequent deposit growth exceeds
the intermediation margin decline. As a result, it also
promotes loans and branch installation with deposits. Two
empirical tests are presented: 1) a regulation change by the
National Bank of Ethiopia in 2011; 2) the introduction of
bank taxes in Antebellum USA (1800-1861). Analyzing bank
balance sheets and long-term branch installation, the
regulation effects are isolated exploiting heterogeneity in
bank size and policies introduction respectively, and find
increases in branches, deposits, loans, and safe assets,
with no decline in overall profits.
