Consequences of monitoring the monitor.

• Position: Banking - Brief article

As the jobs picture brightens, and housing begins its slow recovery, banks will be playing an increasingly important role in screening and monitoring borrowers, but banks sometimes can fail to perform the due diligence necessary to enhance the likelihood of repayment from their borrowers. This begs the question: who monitors the monitor?

The banking business thrives on financial intermediation abilities that allow the lending of money at relatively high interest rates, while receiving money on deposit at relatively low interest rates. This model of capital structure plays an important role in encouraging banks to monitor their borrowers', and their own, financial health.

Research from Simon Business School at the University of Rochester (N.Y.) explains how government safety nets affect the industry. "Our approach examines how banks modify their capital structure in response to changes in the regulation of creditor rights or strengthening the banks legal protection," says Sudarshan Jayaraman, associate professor of accounting and coauthor of the...