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Borrower's moral hazard, risk premium, and welfare : a comparison of universal and stand-alone banking systems.

Banerji, S. and Basu, P. (2015) 'Borrower's moral hazard, risk premium, and welfare : a comparison of universal and stand-alone banking systems.', Journal of economic asymmetries., 12 (1). pp. 61-72.


Does the unification of retail and investment banking necessarily heighten risk in financial markets? Using a simple two period intertemporal model with borrower's moral hazard and uninsured risk, we argue that the integration in financial service markets under universal banking could give rise to a greater risk sharing arrangement. This could eliminate the stock market premium attributed to borrower's moral hazard. Absent any other frictions, we show that there is an unambiguous output and welfare gain from switching to a universal banking system from retail banking because of this efficient risk sharing. This welfare gain is higher in economies prone to greater information friction caused by borrower's moral hazard.

Item Type:Article
Keywords:Moral hazard, Information friction, Risk premium.
Full text:(AM) Accepted Manuscript
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Publisher statement:NOTICE: this is the author’s version of a work that was accepted for publication in The Journal of Economic Asymmetries. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in The Journal of Economic Asymmetries, 12, 1, June 2015, 10.1016/j.jeca.2015.01.003.
Date accepted:31 January 2015
Date deposited:16 February 2015
Date of first online publication:June 2015
Date first made open access:24 August 2016

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