UNIVERSAL BANKING AND FIRM RISK-TAKING

This paper analyzes the welfare implications of banks taking equity st akes in firms under conditions of imperfect information and moral haza rd. Two cases of bank control over investment decisions are analyzed. In the first, the bank does not control the investment decisions of th e firm. Here, the investment efficiency is higher and bank risk is low er for an optimal positive level of bank equity holdings. However, in the case when the bank has veto power over investment proposals by the firm, there is a trade off between increased investment efficiency an d increased bank risk.