Regulation as the provider of incentives/disincentives:

Regulations that bank need to comply by, decide, to a large extent, the risk that can be taken by banks
and financial intermediaries. Loose regulations incentivize banks to take unwarranted risks in pursuit of
profit maximization. For example, regulations that are against setting aside capital for off-balance sheet
liabilities incentivize banks to go for off-balance sheet financing. This increases the contingent
liabilities of the bank to the extent that it can wipe out a large proportion of the capital.
As pointed out in the dialogue, Risk-insensitive deposit insurance pricing led banks to take on higher
risks as it was hedged by low cost put options in the form of insurance. During the financial crisis in the
S&L and banking industries, as mentioned in the dialogue, most S&Ls had negative economic net
worth. Since the contemporary regulations did not address this issue, the banks were incentivized to
continue such practices, eventually leading to the crisis. Thus, it is the regulatory environment which
provides incentives or disincentives for the banks to take actions for shareholder wealth maximization,
which is misconstrued as exploitation by the banks.
On the other hand, regulatory uncertainty, a risk that can never be diversified away, acts as a
disincentive to increase profitability through riskier lending and increases the cost of capital of these
banks. Regulations that restrict the investments of bank by mandating a portion of deposits to be
invested in risk free assets, is a disincentive for the bank to search for more profitable investment
avenues, which is against the interests of shareholders. Business lending, a key activity of banks in
which it has expertise, is hindered when overregulation discourages the banks from lending, weakening
the financial intermediation process.