Journal of Financial Economics Vol. 129 No. 3 2018
Financing as a supply chain: The capital structure of banks and borrowers
Abstract
We develop a model of the joint capital structure decisions of banks and their borrowers. Bank leverage of 85% or higher emerges because bank seniority both dramatically reduces bank asset volatility and incentivizes risk-taking by producing a skewed return distribution. Nonfinancial firms choose low leverage to protect their banks, presenting a partial resolution to the low-leverage puzzle. Our setup naturally extends to include government actions as we model bank assets using a modified Basel framework. Deposit insurance and bailout expectations lead banks and borrowers to take on more risk. Capital regulation lowers bank leverage but can increase bank risk due to a compensating increase in borrower leverage. Despite this, doubling current capital requirements reduces bank default risk by up to 90%, with only a small increase in loan interest rates.
- DOI
- 10.1016/j.jfineco.2018.05.008
- Volume
- 129
- Issue
- 3
- Pages
- 510-530
- Language
- en
- Sources
- openalex crossref bibtex:phds-export.bib