ABSTRACT The financial intermediary's choice of operating as a broker with minimal risk exposure or as an asset‐transformer with interest rate risk is modeled as a funds inventory decision made prior to the resolution of uncertainty regarding the borrowing or lending interest rates. It is shown that an increase in the interest rate uncertainty leads the intermediary to reduce its exposure, thereby offering decreased asset‐transformation and more brokerage services. However, a stochastic increase in the interest rates leads to greater asset‐transformation and less brokerage services.

ABSTRACT This paper examines the effects of loan commitments on bank lending behavior in both deposit‐funding and liability management environments. Assuming that the bank lends exclusively under commitments and that the number of commitments exercised is uncertain, the bank must choose its supply of commitments. Given this choice, the bank becomes a passive lender to commitment holders. Our focus on forward credit markets sheds new light on the private bankers' assertion that they do not directly determine their level of lending, but merely “accommodate” the credit needs of their customers. Similarly, the central banker's claimed inability to control monetary aggregates in the short‐run becomes understandable in a new context. It is shown that the advent of liability management will reduce the volume of loan commitments and the expected size of the bank and of the banking system. It is also shown that increased uncertainty regarding borrower takedown behavior diminishes the volume of commitments, expected bank and banking system size.

The authors analyze risk-sensitive, incentive-compatible deposit insurance in the presence of private information and moral hazard. Without deposit-linked subsidies, it is impossible to implement risk-sensitive, incentive-compatible deposit insurance pricing in a competitive, deregulated environment except when the deposit insurer is the least risk averse agent in the economy. The authors establish this formally in the context of an insurance scheme in which privately informed depository institutions are offered deposit insurance premia contingent on reported capital; the result holds for alternative sorting instruments as well. This suggests a contradiction between deregulation and fairly priced, risk-sensitive deposit insurance.