Handbook for Directors of Financial Institutions
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Handbook for Directors of Financial Institutions

Edited by Benton E. Gup

Offers advice from existing directors, scholars and regulators about what good directors need to know. The Handbook for Directors of Financial Institutions offers the practitioner and the scholar a comprehensive guide to what it takes to survive and thrive as a director of a financial institution. The authors comprise current directors of banks, credit unions, insurance companies and other organizations, bank regulators, lawyers and academics. They provide unique insights and advice about corporate social responsibility, legal risks, starting a new bank, D & O insurance, sub prime lending, Islamic banking, and other timely issues.
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Chapter 9: Bank Directors and the Information Problem with Special Regard to Subprime Markets

Júlia Király and Katalin Mérö


Júlia Király and Katalin Mérö 9.1 Introduction One of the issues of banking involves asymmetric information. Bank directors face the problem of asymmetric information in two senses. First, the bank as a lender is less informed than its customers as borrowers. The board of directors has to take strategic decisions under conditions of imperfect information. Second, non-executive directors are always less informed than the executive management. An appropriate reporting system is required to fill in this information gap. The initial problem is the classical “asymmetric information” situation first analysed by Stiglitz and Weiss (1981). Their main conclusion was that the problem may lead to credit rationing and non-market-clearing equilibrium. The basic assumption was that bank management is risk-averse and makes decisions in a neutral environment. In this chapter a slightly different situation will be analysed. We highlight a special market with one dominant local player and several subsidiaries of foreign banks, who are eager to seize the market even at higher risk. At the same time, the clientele comprises retail customers who earlier had been strictly liquidity-constrained, while the newly available bank loans make it possible for them to smooth their consumption path and invest in real estate. The situation is a special one in that there is a less risk-averse lender aiming to increase its market share and a less risk-averse borrower who overappreciates the availability of credit to its high cost. Directors have to find a reliable strategic path to become a “responsible lender...

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