TY - JOUR
T1 - Ethics, capital and talent competition in banking
AU - Song, Fenghua
AU - Thakor, Anjan
N1 - Funding Information:
☆ For their helpful comments, we thank Jason Donaldson, Paolo Fulghieri (discussant), Stuart Greenbaum, Jennifer Huang, Doron Levit (discussant), Alan Morrison (discussant), Zhen Zhou, Stuart Zimmerman, participants in seminars at Washington University in St. Louis, Wharton-University of Pennsylvania Law School, the Central Bank of Portugal, Goethe University, BI Oslo, University of Illinois, CKGSB, PBCSF, the 2019 RFS-Bocconi-Sapienza Conference on New Frontiers in Banking in Milan, the 2019 RCFS Conference in Hong Kong, the 2019 Stony Brook International Conference on Game Theory, and the 2019 Oxford Financial Intermediation Theory Conference (OxFIT), and especially an anonymous referee and editor of this journal. We alone are responsible for any remaining errors.
Publisher Copyright:
© 2022 Elsevier Inc.
PY - 2022/10
Y1 - 2022/10
N2 - We model optimal ethical standards, capital requirements and talent allocation in banking. Banks with varying safety-net protections, including depositories and shadow banks, innovate products and compete for talent. Managers dislike unethical behavior, but banks heed it only because detection imposes costs. We find: (i) higher capital induces higher ethical standards, but socially optimal capital requirements may tolerate some unethical behavior; (ii) managerial ethics fails to raise banks’ ethical standards; (iii) banks with lower ethical standards attract better talent and innovate more; and (iv) it is socially optimal to allocate better talent to shadow banks instead of depositories, and this allocation results in higher capital requirements and ethical standards for depositories. Consequently, with capital capacity constraints, the shadow banking sector is larger than the depository sector; talent competition induces a race to the bottom in ethical standards, and the regulator responds by setting capital requirements to magnify this size difference.
AB - We model optimal ethical standards, capital requirements and talent allocation in banking. Banks with varying safety-net protections, including depositories and shadow banks, innovate products and compete for talent. Managers dislike unethical behavior, but banks heed it only because detection imposes costs. We find: (i) higher capital induces higher ethical standards, but socially optimal capital requirements may tolerate some unethical behavior; (ii) managerial ethics fails to raise banks’ ethical standards; (iii) banks with lower ethical standards attract better talent and innovate more; and (iv) it is socially optimal to allocate better talent to shadow banks instead of depositories, and this allocation results in higher capital requirements and ethical standards for depositories. Consequently, with capital capacity constraints, the shadow banking sector is larger than the depository sector; talent competition induces a race to the bottom in ethical standards, and the regulator responds by setting capital requirements to magnify this size difference.
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U2 - 10.1016/j.jfi.2022.100963
DO - 10.1016/j.jfi.2022.100963
M3 - Article
AN - SCOPUS:85126039244
SN - 1042-9573
VL - 52
JO - Journal of Financial Intermediation
JF - Journal of Financial Intermediation
M1 - 100963
ER -