Uncertainty,trust, and the regulation of the banking industry |
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Authors: | Enzo Dia |
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Institution: | 1.Dipartimento di Economia Politica,Università degli Studi di Milano-Bicocca,Milan,Italy |
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Abstract: | This paper suggests that, in presence of uncertainty, individual choices are made on the basis of subjective evaluations,
and the transmission of information is too expensive, so that the decision-making process must largely be based on other agents’
knowledge. Banks operate by developing a network of personal relationships, based on trust, that allows agents to make use
of the subjective knowledge of others. The deregulation process of the financial industry of the 1990s was based on the principle
that information disclosure would make the market for securities more efficient, increasing risk diversification, and making
the financial system safer. Many innovative financial contracts, however, were not backed by trust and reputation mechanism
as traditional banking activities. The shadow banking system emerging from these market-based transactions was thus much more
risky and fragile than the traditional one, based on private information and unwritten rules of conduct. |
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