A Theory of Bank Capital / Douglas W. Diamond, Raghuram G. Rajan.

Format:

Book

Author/Creator:

Diamond, Douglas W.

Contributor:

National Bureau of Economic Research.

Rajan, Raghuram G.

Series:

Working Paper Series (National Bureau of Economic Research) no. w7431.

NBER working paper series no. w7431

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1999.

Summary:

Banks can create liquidity because their deposits are fragile and prone to runs. Increased uncertainty can make deposits excessively fragile in which case there is a role for outside bank capital. Greater bank capital reduces liquidity creation by the bank but enables the bank to survive more often and avoid distress. A more subtle effect is that banks with different amounts of capital extract different amounts of repayment from borrowers. The optimal bank capital structure trades off the effects of bank capital on liquidity creation, the expected costs of bank distress, and the ease of forcing borrower repayment. The model can account for phenomena such as the decline in average bank capital in the United States over the last two centuries. It points to overlooked side-effects of policies such as regulatory capital requirements and deposit insurance.

Notes:

Print version record

December 1999.