Working Paper

Private money and banking regulation

Abstract: We show that a competitive banking system is inconsistent with an optimum quantity of private money. Because bankers cannot commit to their promises and the composition of their assets is not publicly observable, a positive franchise value is required to induce the full convertibility of bank liabilities. Under perfect competition, a positive franchise value can be obtained only if the return on bank liabilities is sufficiently low, which imposes a cost on those who hold these liabilities for transaction purposes. If the banking system is monopolistic, then an efficient allocation is incentive-feasible. In this case, the members of the banking system obtain a higher return on assets, making it feasible to pay a sufficiently high return on bank liabilities. Finally, we argue that the regulation of the banking system is required to obtain efficiency.

Keywords: Private money; Banking structure; Regulation;

JEL Classification: E42; G21; G28;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2015-04-09

Number: 15-19

Pages: 46 pages