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This article provides a theoretical framework to analyze the impact of banking regulation on the risk-taking behavior of banks by incorporatig the incentives of three risk-neutral agents - the welfaristic regulator, the shareholder and the manager. While shareholders are assumed to maximize the discounted flow of bank profits, bank managers maximize expected income choosing from a menu of portfolios with different risk-return profiles. We show under which conditions capital requirements intensify the agency conflict between shareholders and bank managers if complete contracts are impossible. As a result, a government interested in alleviating this divergence will incorporate capital requirements to curb risk-appetite only in those cases in which managerial myopia and the probability of default in the banking-sector are not substantial. Moreover, our model suggests that direct regulation of a manager's bonus system is a substitute for any form of capital requirements.

The rise of a crisis-prone banking sector and its political power has received significant attention following the most recent financial crisis. The crisis sparked a growing interest in understanding how and why we have created a world of large, unstable banks. Excessive banking activity arose by design. Using theoretical models from a public choice perspective, the thesis rationalizes this trend as the outcome of political decisions. The thesis argues that the asymmetric information on the costs of banking regulation (and on the social value of making credit available to selected borrowers) incentivizes politicians to combat banking panics and equally preserve electoral support through the smart design of banking rules, i.e. the steering of credit flows and most importantly the provision of an underpriced safety net for the banking business. However, this incentive structure has produced a regulatory framework that now favors the emergence of large, systemically important financial institutions and catalyzes moral hazard behavior. Once established, the created rents for banking activity are likely to persist due to political and institutional lock-in effects. This thesis discusses the linkages between banking regulation, rents and financial intermediation in five chapters, which can be broadly structured into two parts.

The rise of a crisis-prone banking sector and its political power has received significant attention following the most recent financial crisis. The crisis sparked a growing interest in understanding how and why we have created a world of large, unstable banks. Excessive banking activity arose by design. Using theoretical models from a public choice perspective, the thesis rationalizes this trend as the outcome of political decisions. The thesis argues that the asymmetric information on the costs of banking regulation (and on the social value of making credit available to selected borrowers) incentivizes politicians to combat banking panics and equally preserve electoral support through the smart design of banking rules, i.e. the steering of credit flows and most importantly the provision of an underpriced safety net for the banking business. However, this incentive structure has produced a regulatory framework that now favors the emergence of large, systemically important financial institutions and catalyzes moral hazard behavior. Once established, the created rents for banking activity are likely to persist due to political and institutional lock-in effects. This thesis discusses the linkages between banking regulation, rents and financial intermediation in five chapters, which can be broadly structured into two parts.

Why do some economic systems depend on bank financing while others rely on capital markets and bond financing? We propose a political economy model in which elites favor a bank-based system, which increases their rents due to reduced competition. If suffrage is restricted to the elite, this will result in poor corporate control rights and more reliance on banks that offer substitute mechanisms of corporate governance. The lack of legal rights in history triggers path dependencies and explains the dominance of banks until this day. We test the model's predictions by tracking the emergence and evolution of the bank-based financial system in Germany since the 19th century.

The paper argues that national regulators can improve the stability of the domestic banking sector via two substitutable policy instruments; minimum capital requirements and effort spend on domestic supervision. Both tools increase the soundness of a national banking system, but they imply different cost burdens between domestic banks and taxpayers. The optimal domestic policy choice is characterised by trading off marginal costs and benefits born by each party. However, the optimal policy choice changes if banks are allowed to be mobile. We show that countries are better off by harmonising capital requirements on an international standard la Basel, since harmonisation counters a regulatory race with other jurisdictions and will increase national utility.

We develop a simple model of banking regulation with two policy instruments: minimum capital requirements and supervision of domestic banks. The regulator faces a trade-off: high capital requirements cause a drop in the banks'; profitability, while strict supervision reduces the scope of intermediation and is costly for taxpayers. We show that the expected costs of a banking crisis are minimised with a mix of both instruments. Once we allow for cross-border banking, the optimal policy is not feasible. If domestic supervisory effort is not observable, our model predicts a race to the bottom in banking regulation. Therefore, countries are better off by harmonising regulation on an international standard.

The rise of a crisis-prone banking sector and its political power has received significant attention following the most recent financial crisis. The crisis sparked a growing interest in understanding how and why we have created a world of large, unstable banks. Excessive banking activity arose by design. Using theoretical models from a public choice perspective, the thesis rationalizes this trend as the outcome of political decisions. The thesis argues that the asymmetric information on the costs of banking regulation (and on the social value of making credit available to selected borrowers) incentivizes politicians to combat banking panics and equally preserve electoral support through the smart design of banking rules, i.e. the steering of credit flows and most importantly the provision of an underpriced safety net for the banking business. However, this incentive structure has produced a regulatory framework that now favors the emergence of large, systemically important financial institutions and catalyzes moral hazard behavior. Once established, the created rents for banking activity are likely to persist due to political and institutional lock-in effects. This thesis discusses the linkages between banking regulation, rents and financial intermediation in five chapters, which can be broadly structured into two parts.