NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Redistributive Effects of Financial Deregulation

Anton Korinek, Jonathan Kreamer

NBER Working Paper No. 19572
Issued in October 2013
NBER Program(s):   CF   EFG   IFM

Financial regulation is often framed as a question of economic efficiency. This paper, by contrast, puts the distributive implications of financial regulation center stage. We develop a model in which the financial sector benefits from risk-taking by earning greater expected returns. However, risk-taking also increases the incidence of large losses that lead to credit crunches and impose negative externalities on the real economy. Assuming incomplete risk markets between the financial sector and the real economy, we describe a Pareto frontier along which different levels of risk-taking map into different levels of welfare for the two parties. A regulator has to trade off efficiency in the financial sector, which is aided by deregulation, against efficiency in the real economy, which is aided by tighter regulation and a more stable supply of credit. We also show that financial innovation, asymmetric compensation schemes, concentration in the banking system, and bailout expectations enable or encourage greater risk-taking and allocate greater surplus to the financial sector at the expense of the rest of the economy.

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Document Object Identifier (DOI): 10.3386/w19572

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