Bank Opacity and Financial Crises
Bank opacity is costly for society because it reduces market discipline and encourages banks to take on too much risk. I show that banks choose to be inefficiently opaque if the composition of a bank’s balance sheet is proprietary information. Strategic competition reduces transparency and increases the risk of a banking crisis. The model can explain why empirically a higher degree of bank competition leads to increased transparency. Optimal public disclosure requirements may make banks more vulnerable to a run for a given investment policy, but they reduce the risk of a run through an improvement in market discipline. The option of public stress tests is beneficial if the policy maker has access to public information only. This option can be harmful if the policy maker has access to banks’ private information.