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The financial crisis of 2007-2008 has unveiled the hidden flaws in the regulatory framework of the financial sector. The rules of the game established by regulators were not stringent enough and provided bankers with wrong incentives to gamble with depositors’ money. There are two major challenges in the design of new rules in banking. First, bank assets are opaque, and regulators do not perfectly observe the risks involved. The second challenge is that bankers’ behavior changes in response to changes in regulation. This results in regulatory arbitrage.
This thesis includes three essays on banking. The first two focus on the problem of bank asset opacity in the banking regulatory design. The third essay focuses on the regulatory arbitrage.
The first essay "Convertible Bonds and Bank Risk-Taking" (joint with Enrico Perotti) studies the effect of going concern contingent capital on ex ante bank risk-taking incentives. The second essay "Internal Asset Transfers and Risk-Taking in Financial Conglomerates" considers the risk control decision and risk allocation choice via securitization in financial conglomerates organized as a bank holding company. The third essay "Franchise Value and Risk-Taking in Modern Banks" (joint with Lev Ratnovski and Razvan Vlahu) studies how the value of bank relationship business induces risk-shifting through investment in scalable market-based activities.