Dr Norvald Instefjord (University of Essex): Loan Monitoring and Bank Risk
We study the optimal use of loan monitoring systems in regulated banks, where the bank chooses which loans to monitor and the regulator imposes regulatory costs for holding risky loans.
We find that improvements in monitoring technology increase the value and monitoring activity of loans, and therefore also the incentive to hold risky loans under monitoring. A regulator controlling bank risk will respond by imposing greater financial penalties on risky lending. Improvements in monitoring technology carry therefore both costs and benefits, and our contribution is to show that the costs always outweigh the benefits and that the bank therefore gains from destroying its monitoring technology. We discuss the implications of this finding for bank regulation.
An Economics and Finance research seminar.