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Restoring Trust in Banking

Published online by Cambridge University Press:  26 March 2020

Angus Armstrong
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Abstract

Trust allows financial transactions to take place when contracts are incomplete and the cost of negotiating too great for the parties involved. Banking covers many different types of transactions in assets with different levels of incomplete contracts. Investment banks have traditionally dealt with assets with incomplete contracts and often traded on informal and opaque markets. The creation of new global banks combined know-how, capital and collateral to generate enormous growth in these markets. While global banks developed trust with counterparties in specific markets, the opacity combined with limited liability structures also created principal-agent problems. The scandals which emerged are a reflection of these agency problems and have left trust in the banks greatly diminished. If levels of trust remain so low, this will be consistent with ongoing bank vulnerability, less lending to finance risky but profitable investment projects, and consequently lower economic activity. Regulation can support private incentives to accept codes of conduct which enhance trust.

Keywords

Trustincomplete contractsprincipal-agentfinancial regulationfinancial reformG11G32G38L22
Type
Research Articles
Information
National Institute Economic Review , Volume 221 , July 2012 , pp. R4 - R10
Copyright
Copyright © 2012 National Institute of Economic and Social Research

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Footnotes

∗

National Institute of Economic and Social Research. E-mail: [email protected]. This article follows from a speech given to the Government Economic Service in January 2011. The author was an economist for Morgan Grenfell and Deutsche Bank between 1990 and 2000.

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