Abstract

This paper develops a dynamic continuous-time model of optimal bank liability structure that incorporates the liquidity services on deposits, deposit insurance, regulatory closure, and endogenous default in banks' financing decisions. Nesting the classic model for non-financial firms as a special case, the model clearly explains why banks use higher leverage than non-financial firms. The model shows that a value-maximizing bank balances between deposits and debt so that its endogenous default coincides with the regulatory closure in order to maximize the tax benefits of debt and minimize the protection for deposits. Banks' optimal responses to regulatory changes often counteract regulators' objectives.

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Citation

Sundaresan, M. Suresh, and Zhenyu Wang. "Bank Liability Structure." Columbia Business School, March 2014.

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