Optimal bank interest margin under the FDIC’s surveillance : a constrained option-based model

Abstract

This paper examines the relationships between the Federal Deposit Insurance Corporation’s (FDIC’s) surveillance cost, optimal bank interest margin and deposit-amount determination. The framework utilized in this paper is the bank equity call option maximization subject to the put option of the FDIC’s risk-adjusted deposit insurance, explicitly considering surveillance cost. An increase in the FDIC’s surveillance cost results in an increased loan-rate setting and a reduced deposit-amount determination if the bank’s marginal market risky loans value is negative. Our findings provide an alternative explanation for the agency theory concerning a principal-agent issue of hidden action.