April, 2016

Extended Shareholder Liability as a Means to Constrain Moral Hazard in Insured Banks

  • Lawrence H. White

    Distinguished Senior Fellow, F. A. Hayek Program for Advanced Study in Philosophy, Politics and Economics
  • Alexander Salter

    Assistant Professor of Economics, Texas Tech University
  • Vipin Veetil

    Assistant Professor, Indian Institute of Technology Madras
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Find the paper at ScienceDirect. 

Extended liability for bank shareholders offers a possible method for mitigating moral hazard in insured banks. The dominant approach to maintaining financial stability seeks to constrain banks’ profit-maximizing responses to distorted incentives by means of ad hoc restrictions. By contrast, extended liability seeks to create healthier incentives. We examine how a variety of extended liability regimes worked historically, and consider leading concerns about their potential disadvantages. We conclude by discussing how extended liability avoids the difficulties of both ‘microprudential and ‘macroprudential’ approaches to systemic stability.