Date Added: Sep 2010
The authors study how political choices on the allocation of bank control affect bank instability. The political trade o? between lobby contributions and social welfare is determined by political accountability. When accountability is low, inefficient state banks are chosen to maximize extraction. As accountability rises, a shift to private control reduces inefficiency. At the transition point bank risk taking jumps, as private owners do not internalize all costs of failure. As accountability rises further, two effects arise. First, politicians allow higher private rents to discourage risk taking. Second, bank ownership becomes more dispersed and entry increases, decreasing solvency incentives.