Ecmrpfmb Manual 07012010

ECMRPFMB
Regulatory Policy in Financial Markets and Banking
Course information
Code ECMRPFMB
Period 3
Timeslot A
Credits 7.5 ECTS
In master Economics and Law, Utrecht University School of Economics
Department USE/Finance and Financial Markets
Co-ordinator Dr. J.W.B. Bos (Jaap, j.w.b.bos@uu.nl)
Lecturer Dr. J.W.B. Bos (Jaap, j.w.b.bos@uu.nl)
Position in the Curriculum

This course is part of the Economics and Law program. It aims to bridge the gap between
a theoretical and empirical approach to regulatory policy in financial markets and banking.
It approaches regulatory policy as a reaction to market failure. Good knowledge of microe-
conomics is assumed as well as basic knowledge of finance (Corporate Finance (ECB2FIN)).
The course requires a basic level of calculus and statistics (regression analysis). In the course,
we will use a combination of competition theory (first half) and empirics (second half).
Contents
In this course, we develop a theory of financial intermediation that allows us to explain the role
of banks in the economy, highlight structural weaknesses of the financial sector and justify and
interpret regulatory policy. We will study reasons for the existence of financial intermediaries,
including transaction costs, liquidity insurance and search costs. Building on this knowledge
we will study theoretical models of competition in the banking sector and risk management.
From there, we will study the choice of a regulatory framework, the role of a central bank and
moral hazard in deposit insurance. We will finish the theoretical part of the course with an
overview of recent developments in banking regulation (Basel II) and other financial regulation
(e.g. Financial Regulatory Framework for insurance firms).
In the second half of the course, we will use a sample data set to empirically test competitive
behavior in banking. We start with simple concentration measures, and measure transaction
costs (economies of scale). Then we compare price and non-price competition models. We
build several reduced-form competition models and estimate them with our sample data. In
addition, we review existing empirical evidence, such as spatial competition models.
ECMRPFMB – Academic year 2009/2010

1/14
Language of instruction
English.
Learning Goals
At the end of the course the student is able to:
{ Apply the concepts of the role of transaction costs, liquidity insurance, moral hazard and
adverse selection to financial markets and banking;
{ formally establish the link between (competition) theory and empirical tests;
{ explain the justification for, impact of and limitations of financial regulation;
{ measure and interpret the relationship between the production of the banking firm, the level
and type of competition on banking markets, and the stability and regulation of the financial
system;
{ explain policy implications of firm behavior on the basis of theoretical and empirical evidence;
{ interpret firm behavior by selecting the appropriate tools from a coherent analytical framework;
{ understand and critically evaluate current advancements in the literature;
{ carry out independent empirical research with a solid theoretical foundation;
{ communicate in English;
{ solve problems.
General format
There will be lectures and tutorials for discussing papers, capita selecta and exercises.
Lectures
Weekly lectures serve several goals. First, they aim to create a synthesis between the book
chapters, the articles, and the empirical exercises. Second, they serve to deepen the analyses
presented in the obligatory literature. Students are expected to have read and studied in
advance the relevant literature. Lecture slides will be made available through WebCT and - if
possible - before the lectures. Lecture notes are thereby also part of the compulsory material
for the written exam. Attendance at the lectures is voluntary. Three hours per lecture have
been scheduled.
Tutorials
In the weekly tutorial groups, we will cover parts of the obligatory literature. Students are
required to participate actively and will take turns in introducing a subject. The coordinator
will lead these meetings, but students are expected to prepare with the help of the information
in the course manual and additional information given during the lectures.

2/14
Paper assignment
The paper assignment focuses on the academic skill "Being able to carry out independent
empirical research with a solid theoretical foundation." Objective of the paper is to analyze the
degree and type of competition in a banking market. To this purpose, students are expected
to use a data set provided by the course coordinator to: (i) measure market concentration;
(ii) estimate the level of competition in a market; (iii) interpret the results; (iv) policy advice.
Each student gets assigned to one of the models studied at this point in the course, and is
expected to write an empirical paper using this particular model.
Academic reasoning is a prerequisite here, as students are expected to (a) define an interesting
problem statement; (b) go beyond the standard theory; (c) relate their empirical results to a
set of policy recommendations. In week 3 of the course, a tutorial will be given by the course
coordinator on the data set that is to be used, the stata programs distributed in the course
and the general outline of the paper.
Assessment method
{ Student performance is tested by means of an open book final exam (60% of the final grade)
as well as by his/her performance on a paper assignment (40% of the final grade).
{ Performance with respect to the paper depends on the choice of problem statement, the
information collection, level of the empirical analysis, independence of the method of working;
general level of the discussion and the policy recommendations. The grade for the paper is
valid only for the current academic year.
{ The final, written exam consists of a number of essay questions. We will prepare for the
exam with a number of practice questions. It is an open book exam, based on the mandatory
literature and the lecture notes. All written material can be brought to the exam for actual
use.
{ In case a student fails the course and has a chance to pass by improving an insufficient grade
(< 6) for the paper, he/she has two options:
(a) Rewrite the paper. In this case, the grade for the final exam remains unaltered, and the
student passes up the chance to take part in a resit exam.
(b) Take the resit exam. In this case, the grade for the resit exam will be the final grade for
the course.
{ In case a student fails the course and has an insufficient grade for the final exam (< 6), the
student is entitled to a resit exam. The grade for this resit exam will be the final grade for
the course.
{ The resit exam consists of an oral exam of one hour. All written material can be brought to
the resit exam for actual use.
Consistency learning objective - task/assignment - assessment

Learning objective Task/assignment Assessment
apply concepts tutorial groups exam
link between theory and empirics paper paper
explain regulation tutorial groups exam
link between concepts tutorial groups paper/exam
explain policy implications of firm behavior tutorial groups/paper paper
understand and evaluate relevant literature paper paper
carry out independent research paper paper
communicate in English paper/exam paper/exam
solve problems paper/exam paper/exam

3/14
Program
Week Theme Task Format
1 Introduction
General introduction/What is a bank? Study Lecture
Why do financial intermediaries exist? Study and prepare Tutorial
2 Asymmetric information
Transformation Study Lecture
Costly monitoring and credit rationing Study and prepare Tutorial
3 Competition theory and practice
Competition models Study Lecture
Stata and data, and market structure Study and prepare Tutorial
4 Regulatory incentives
Why regulate banks? Study Lecture
Investors’ incentive schemes Study and prepare Tutorial
5 Regulatory theory
Market information Study Lecture
Economics of banking regulation Study and prepare Tutorial
6 Regulatory practice
Relationships and lending Study Lecture
Deposit Insurance Study and prepare Tutorial
7 Paper
Progress meeting - -
Mergers Study and prepare Tutorial
8 Competition revisited...
Alternative ways to study Competition Study/deadline paperLecture
Monti-Klein and Salop Study and prepare Tutorial
9 Guest lectures
Course materials
The course makes use of selected chapters from two books and a manuscipt (co-authored by
the coordinator). The latter will be available from the coordinator. Datasets, instruction files
and handouts will also be made available through WebCT by the coordinator.
{ Bikker, J.A. and J.W.B. Bos (2005). Bank Performance: a theoretical and empirical frame-
work for the analysis of profitability, competition and efficiency, manuscript;
{ Dewatripoint, M. and J. Tirole (1995). The Prudential Regulation of Banks. Cambridge,
Massachusetts, USA: MIT Press. In reader.
{ Freixas, X, J-C. Rochet (1998). Microeconomics of Banking, Cambridge, Massachusetts,
USA: MIT Press. In reader.
{ Basel Committee on Banking Supervision (2001), "The New Basel Capital Ac-
cord: an explanatory note," Bank for International Settlements Note (available from
http://www.bis.org/publ/bcbsca01.pdf).
{ Berger, A.N., R.S. Demsetz and P.E. Strahan, 1999. "The Consolidation of the Financial
Services Industry: Causes, Consequences, and Implications for the Future," Journal of Banking
& Finance, 23 (2-4), February, pp. 135-194.
{ Bhattacharya, S. and A.V. Thakor (1993), "Contemporary banking theory," Journal of financial
intermediation, 3 (1), 2-50.
{ Bhattacharya, S., A.W.A. Boot and A.V. Thakor (1998), "The Economics of banking regula-
tion," Journal of Money, Credit and Banking, 30 (4) 745-770.
{ Bikker, J.A. and K. Haaf (2002), "Competition, concentration and their relationship: An
empirical analysis of the banking industry," Journal of Banking & Finance, 26(11), 2191-
2214.

4/14
{ Bikker, J.A. and K. Haaf (2000), "Measures of competition and concentration in the banking
industry: a review of the literature," De Nederlandsche Bank Research Series Supervision, 27
(http://ideas.repec.org/p/dnb/ressup/27.html).
{ Boot, A.W. and A.V. Thakor (1997), "Financial System Architecture," The Review of Financial
Studies, 10 (3), 693-733.
{ Bos, J.W.B. (2004), "Does market power affect performance in the Dutch banking market?
A comparison of reduced form market structure models," De Economist, 152 (4), 491 –512.
{ Cetorelli, N. and P.E. Strahan (2004), "Finance as a Barrier to Entry: Bank Competition and
Industry Structure in Local U.S. Markets," Federal Reserve Bank of Chicago Working paper,
WP 2004-04
(http://www.chicagofed.org/publications/workingpapers/).
{ Chiappori, P.-A., D. Perez-Castrillo and T. Verdier (1995), "Spatial competition in the banking
system: Localization, cross subsidies and the regulation of deposit rates," European Economic
Review, 39, 889-918.
{ Cole, R.A., L.G. Goldberg and L.J. White (2004), "Cookie-Cutter versus Character: The
Micro Structure of Small-Business Lending by Large and Small Banks," Journal of Financial
and Quantitative Analysis, 39 (2), (available as a working paper, 1999, pp. 362-389
(http://www.chicagofed.org/cedric/)).
{ Dvor̆ák, P. (2005), "Rethinking the Monti-Klein Model of Banking Industry: New Insights
about the Separability of Loans and Deposits Decisions" , CERGE-EI Discussion Paper, 2005-
138
(https://www.cerge-ei.cz/pdf/dp/DP138_2005.pdf).
{ Flood, M.D. (1992), " The Great Deposit Insurance Debate,"Federal Reserve Bank of St.
Louis Review, July/August
(http://research.stlouisfed.org/publications/review/92/07/Deposit_Jul_Aug1992.pdf).
{ Gai, P. and H.S. Shin (2003), "Transparency and financial stability" , Bank of England Finan-
cial Stability Review
(http://www.bankofengland.co.uk/publications/fsr/2003/fsr15art5.pdf).
{ Gilbert, R.A. (1990), "Market Discipline of Bank Risk: Theory and Evidence," Federal Reserve
Bank of St. Louis Review, January/February
(http://research.stlouisfed.org/publications/review/90/01/Discipline_Jan_Feb1990.pdf).
{ Gropp, R., J. Vesala and G. Vulpes (2004), "Equity and Bond Market Signals as Leading
Indicators of Bank Fragility," Journal of Money, Credit and Banking, forthcoming
(http://webmail.econ.ohio-state.edu/john/Upcoming.php).
{ Jones, K.D. and T. Critchfield (2004), "The Declining Number of U.S. Banking Organizations:
Will the Trend Continue?," FDIC Future of Banking Study, Draft FOB-2004-02.1
(http://www.fdic.gov/bank/analytical/future/fob_02.pdf).
{ Santomero, A.M. (1997), "Deposit Insurance: Do We Need It and Why?," Wharton Financial
Institutions Center Working Paper, 97-35
(http://fic.wharton.upenn.edu/fic/papers/97/9735.pdf).
{ Yan, Y. (1996), "Credit Rationing, Bankruptcy Cost, and Optimal Debt Contract for Small
Business," Federal Reserve Bank of Cleveland Working Paper, 12
(http://econwpa.wustl.edu:8089/eps/fin/papers/9612/9612003.pdf).
Course itinerary
On the following pages, you find a week-by-week overview of the course.

5/14
Week 1
Topic Introduction
Lecture 1: General introduction/What is a bank?
Date Monday February 8

Location UCU-U
Time 09:00-12:45
Literature Chapter 1 of Freixas, X and J-C. Rochet (1998). Microeconomics of Banking, Cambridge,
Massachusetts, USA: MIT Press (in reader).
Remarks Prepare, read the article(s) carefully and check derivations.
Tutorial 1: Why do financial intermediaries exist?
Date Wednesday February 10

Location UCU-U
Time 11:00-12:45
Literature Chapter 2 of Freixas, X and J-C. Rochet (1998). Microeconomics of Banking, Cambridge,
Massachusetts, USA: MIT Press (in reader).
Remarks Prepare, read the article carefully and check derivations. If you have been asked to lead the dis-
cussion about this article, prepare extra carefully and start the session with a small presentation
about the key features of the article.

6/14
Week 2
Topic Asymmetric information
Lecture 2: Transformation

Location UCU-U
Time 09:00-12:45
Literature Boot, A.W. and A.V. Thakor (1997), "Financial System Architecture," The Review of Financial
Studies,10 (3), 693-733.
Tutorial 2: Costly monitoring and credit rationing

Location UCU-U
Time 11:00-12:45
Literature Yan, Y. (1996), "Credit Rationing, Bankruptcy Cost, and Optimal Debt Con-
tract for Small Business," Federal Reserve Bank of Cleveland Working Paper, 12
(http://econwpa.wustl.edu:8089/eps/fin/papers/9612/9612003.pdf).

7/14
Week 3
Topic Competition theory and practice
Lecture 3: Competition models

Location UCU-U
Time 09:00-12:45
Literature Bikker, J.A. and J.W.B. Bos (2008). Bank Performance: a theoretical and empirical framework
for the analysis of profitability, competition and efficiency.
Bos, J.W.B. (2004), "Does market power affect performance in the Dutch banking market? A
comparison of reduced form market structure models," De Economist, 152 (4), 491 –512.
Tutorial 3: Stata, data and market structure

Location UCU-U
Time 11:00-12:45
Literature Bikker, J.A. and J.W.B. Bos (2008). Bank Performance: a theoretical and empirical framework
for the analysis of profitability, competition and efficiency.
Bikker, J.A. and K. Haaf (2002), "Competition, concentration and their relationship: An em-
pirical analysis of the banking industry," Journal of Banking & Finance, 26(11), 2191-2214.
Bikker, J.A. and K. Haaf (2000), "Measures of competition and concentration in the banking
industry: a review of the literature," De Nederlandsche Bank Research Series Supervision, 27
(http://ideas.repec.org/p/dnb/ressup/27.html).
Handout (Stata).

8/14
Week 4
Topic Regulatory incentives
Lecture 4: Investors’ incentive schemes
Date Monday March 1

Location UCU-U
Time 09:00-12:45
Literature Bhattacharya, S. and A.V. Thakor (1993), "Contemporary banking theory," Journal of financial
intermediation, 3 (1), 2-50.
Tutorial 4: Investors’ incentive schemes
Date Wednesday March 3

Location UCU-U
Time 11:00-12:45
Literature Chapters 6 and 7 from Dewatripoint, M. and J. Tirole (1995). The Prudential Regulation of
Banks. Cambridge, Massachusetts, USA: MIT Press (reader).

9/14
Week 5
Topic Regulatory theory
Lecture 5: Economics of banking regulation
Date Monday March 8

Location UCU-U
Time 09:00-12:45
Remarks No teaching!
Tutorial 5: Market information

Location UCU-U
Time 11:00-12:45
Literature Chapter 8 from Dewatripoint, M. and J. Tirole (1995). The Prudential Regulation of Banks.
Cambridge, Massachusetts, USA: MIT Press (reader).

10/14
Week 6
Topic Regulatory theory
Lecture 6: Economics of banking regulation
Date Monday March 15

Location UCU-U
Time 09:00-12:45
Literature Bhattacharya, S., A.W.A. Boot and A.V. Thakor (1998), "The Economics of banking regula-
tion," Journal of Money, Credit and Banking, 30 (4) 745-770.
Tutorial 6: Market information

Location UCU-U
Time 11:00-12:45
Literature Gai, P. and H.S. Shin (2003), "Transparency and financial sta-
bility", Bank of England Financial Stability Review (Available at:
http://www.bankofengland.co.uk/publications/fsr/2003/fsr15art5.pdf).
Gropp, R., J. Vesala and G. Vulpes (2004),. "Equity and Bond Market Signals as Lead-
ing Indicators of Bank Fragility," Journal of Money, Credit and Banking, forthcoming
(http://webmail.econ.ohio-state.edu/john/Upcoming.php).
Basel Committee on Banking Supervision (2001), "The New Basel Capital Ac-
cord: an explanatory note," Bank for International Settlements Note (available from
http://www.bis.org/publ/bcbsca01.pdf).

11/14
Week 7
Topic Regulatory practice
Lecture 7: Deposit insurance

Location UCU-U
Time 09:00-12:45
Literature Flood, M.D. (1992), "The Great Deposit Insurance Debate," Fed-
eral Reserve Bank of St. Louis Review, July/August (Available at:
http://research.stlouisfed.org/publications/review/92/07/Deposit_Jul_Aug1992.pdf).
Gilbert, R.A. (1990), "Market Discipline of Bank Risk: Theory and Evidence,"
Federal Reserve Bank of St. Louis Review, January/February (Available at:
http://research.stlouisfed.org/publications/review/90/01/Discipline_Jan_Feb1990.pdf).
Santomero, A.M. (1997), "Deposit Insurance: Do We Need It and Why?,"
Wharton Financial Institutions Center Working Paper, 97-35 (Available at:
http://fic.wharton.upenn.edu/fic/papers/97/9735.pdf).
Tutorial 7: Relationships and lending

Location UCU-U
Time 11:00-12:45
Literature Cetorelli, N. and P.E. Strahan (2004), "Finance as a Barrier to Entry: Bank Competition and
Industry Structure in Local U.S. Markets," Federal Reserve Bank of Chicago Working paper,
WP 2004-04 (Available at: http://www.chicagofed.org/publications/workingpapers/).
Cole, R.A., L.G. Goldberg and L.J. White (2004), "Cookie-Cutter versus Character: The Micro
Structure of Small-Business Lending by Large and Small Banks," Journal of Financial and
Quantitative Analysis, 39 (2), (available as a working paper, 1999, pp. 362-389 (Available
at: http://www.chicagofed.org/cedric/)).

12/14
Week 8
Topic Mergers and consolidation
Lecture 8: Consolidation

Location UCU-U
Time 09:00-12:45
Literature Berger, A.N., R.S. Demsetz and P.E. Strahan, 1999. "The Consolidation of the Financial
Services Industry: Causes, Consequences, and Implications for the Future," Journal of Banking
& Finance, 23 (2-4), February, pp. 135-194.
Jones, K.D. and T. Critchfield (2004), "The Declining Number of U.S. Banking Organizations:
Will the Trend Continue?," FDIC Future of Banking Study, Draft FOB-2004-02.1 (Available at:
http://www.fdic.gov/bank/analytical/future/fob_02.pdf).
Tutorial 8: Mergers

Location UCU-U
Time 11:00-12:45
Literature Chapter 8 of Allen, F. and D. Gale (2003), Comparing Financial Systems, Cambridge, Mas-
sachusetts, USA: MIT Press (available from course coordinator).

13/14
Week 9
Topic Capita selecta
Lecture 9: No lecture, since it is Easter!
Tutorial 9: Alternative ways to study competition
Date Wednesday April 7

Location UCU-U
Time 11:00-13:00
Literature Chapter 3 of Freixas, X, J-C. Rochet (1998). Microeconomics of Banking, Cambridge, Mas-
sachusetts, USA: MIT Press (in reader).

14/14

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ECMRPFMB

Regulatory Policy in Financial Markets and Banking

Position in the Curriculum

ECMRPFMB – Academic year 2009/2010

ECMRPFMB – Academic year 2009/2010

Consistency learning objective - task/assignment - assessment

ECMRPFMB – Academic year 2009/2010

ECMRPFMB – Academic year 2009/2010

ECMRPFMB – Academic year 2009/2010

Lecture 1: General introduction/What is a bank?

Date Monday February 8

Tutorial 1: Why do financial intermediaries exist?

Date Wednesday February 10

ECMRPFMB – Academic year 2009/2010

Date Monday February 15

Tutorial 2: Costly monitoring and credit rationing

Date Wednesday February 17

ECMRPFMB – Academic year 2009/2010

Lecture 3: Competition models

Date Monday February 22

Tutorial 3: Stata, data and market structure

Date Wednesday February 24

ECMRPFMB – Academic year 2009/2010

Lecture 4: Investors’ incentive schemes

Date Monday March 1

Tutorial 4: Investors’ incentive schemes

Date Wednesday March 3

ECMRPFMB – Academic year 2009/2010

Lecture 5: Economics of banking regulation

Date Monday March 8

Tutorial 5: Market information

Date Wednesday March 10

ECMRPFMB – Academic year 2009/2010

Lecture 6: Economics of banking regulation

Date Monday March 15

Tutorial 6: Market information

Date Wednesday March 17

ECMRPFMB – Academic year 2009/2010

Lecture 7: Deposit insurance

Date Monday March 22

Tutorial 7: Relationships and lending

Date Wednesday March 24

ECMRPFMB – Academic year 2009/2010

Date Monday March 29

Date Wednesday March 31

ECMRPFMB – Academic year 2009/2010

Lecture 9: No lecture, since it is Easter!

Tutorial 9: Alternative ways to study competition

Date Wednesday April 7

ECMRPFMB – Academic year 2009/2010

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