Abstract

http://ssrn.com/abstract=2254998
 
 

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Liquid-Claim Production, Risk Management, and Bank Capital Structure: Why High Leverage is Optimal for Banks


Harry DeAngelo


University of Southern California - Marshall School of Business - Finance and Business Economics Department

Rene M. Stulz


Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

May 14, 2014

Fisher College of Business Working Paper No. 2013-03-08
Charles A. Dice Center Working Paper No. 2013-8
ECGI - Finance Working Paper No. 356

Abstract:     
Liquidity production is a central function of banks. High leverage is optimal for banks in a model that has just enough frictions for banks to have a meaningful role in liquid-claim production. The model has a market premium for (socially valuable) safe/liquid debt, but no taxes or other traditional motives to lever up. Because only safe debt commands a liquidity premium, banks in the model use risk management to maximize their capacity to include such debt in the capital structure. The model can explain (i) why banks have higher leverage than most operating firms, (ii) why risk management is central to banks’ operating policies, (iii) why bank leverage increased over the last 150 years or so, and (iv) why leverage limits for regulated banks impede their ability to compete with unregulated shadow banks.

Number of Pages in PDF File: 43

Keywords: bank capital requirements, leverage, liquidity

JEL Classification: G21, G32, E42, E51, G01, L51

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Date posted: April 23, 2013 ; Last revised: May 29, 2014

Suggested Citation

DeAngelo, Harry and Stulz, Rene M., Liquid-Claim Production, Risk Management, and Bank Capital Structure: Why High Leverage is Optimal for Banks (May 14, 2014). Fisher College of Business Working Paper No. 2013-03-08; ECGI - Finance Working Paper No. 356. Available at SSRN: http://ssrn.com/abstract=2254998 or http://dx.doi.org/10.2139/ssrn.2254998

Contact Information

Harry DeAngelo
University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )
Marshall School of Business
Los Angeles, CA 90089
United States
213-740-6541 (Phone)
213-740-6650 (Fax)
Rene M. Stulz (Contact Author)
Ohio State University (OSU) - Department of Finance ( email )
2100 Neil Avenue
Columbus, OH 43210-1144
United States
HOME PAGE: http://www.cob.ohio-state.edu/fin/faculty/stulz

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
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