1)How can banks reduce the principal-agent problem associated with trading activities?

2)Who are the agents and who are the principals?

1)

Banks can reduce the principal-agent problem through;

a) The increment in the labor force in banks, specifically hiring more personnel can aid in the reduction of the principal-agent problem. This method, however, heightens costs.

b) Banks can opt to form partnerships that enhance the separation of ownership amongst the partners. This way there is a significant reduction in the principal-agent problem.

c) Banks can as well combat the principal-agent problem by promoting transparency through the reduction of asymmetry in information.

d) Banks should set up the right incentives whereby the managerial executives and the shareholders all understand their roles in the procurement and running of the financial institution.

e) There should be an optimal structure of defining and governing the decision-making system that is not biased so as to reduce instances of conflicts of interest between the management and the shareholders.

2)Agents and principals are the two main characters in agency theory. Agency theory explains the issues arising between agents and principals. According to this theory, the agents are individuals or entities that represent principals in operations that involve managing their resources. They are hired by principals and are paid to make decisions on their behalf. The principals are the owners of resources, most commonly capital, who delegate responsibility for managing it to agents. They supervise agents and require them to act in the principal's interest. Common examples of agents and principals are managers and stockholders, lawyers and their clients, mutual fund managers and their clients, etc.