MORAL HAZARD UNDER COMMERCIAL AND UNIVERSAL BANKING

Many claims have been made about the potential benefits and the potent ial costs of adopting a system of universal banking in the United Stat es. We evaluate these claims using a model where there is a moral haza rd problem between banks and ''borrowers,'' a moral hazard problem bet ween banks and a deposit insurer, and a costly state verification prob lem. Under conditions we describe, allowing banks to take equity posit ions in firms strengthens their ability to extract surplus, and exacer bates problems of moral hazard. The incentives of universal banks to t ake equity positions will often be strongest when these problems are m ost severe.