How much discretion should local financial regulators in a banking union have in accommodating local credit demand? I analyze this question in an economy where local regulators privately observe expected output from high lending. They do not fully internalize default costs from high lending since deposit insurance cannot be priced fairly.
This paper studies an economy where agents can spend resources on consuming a private good and on funding a public good. There is asymmetric information regarding agents’ relative preference for private versus public good consumption.