Moral hazard and optimal subsidiary structure for financial institutions

Charles Kahn, Andrew Winton

Research output: Contribution to journalReview articlepeer-review

44 Scopus citations

Abstract

Banks and related financial institutions often have two separate subsidiaries that make loans of similar type but differing risk, for example, a bank and a finance company, or a "good bank/bad bank" structure. Such "bipartite" structures may prevent risk shifting, in which banks misuse their flexibility in choosing and monitoring loans to exploit their debt holders. By "insulating" safer loans from riskier loans, a bipartite structure reduces risk-shifting incentives in the safer subsidiary. Bipartite structures are more likely to dominate unitary structures as the downside from riskier loans is higher or as expected profits from the efficient loan mix are lower.

Original languageEnglish (US)
Pages (from-to)2531-2575
Number of pages45
JournalJournal of Finance
Volume59
Issue number6
DOIs
StatePublished - Dec 2004

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