Financing as a Supply Chain: The Capital Structure of Banks and Borrowers
Stanford Graduate School of Business
Ilya A. Strebulaev
Stanford University - Graduate School of Business; National Bureau of Economic Research
October 29, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 166
We develop a model of the joint capital structure decisions of banks and their borrowers. Strikingly high bank leverage emerges naturally from the interplay between two sets of forces. First, seniority and diversification reduce bank asset volatility by an order of magnitude relative to that of their borrowers. Second, previously unstudied supply chain effects mean that highly levered financial intermediaries are the most efficient. Low asset volatility enables banks to safely take on high leverage; supply chain effects compel them to do so. Firms with low leverage also arise naturally as borrowers internalize the systematic risk costs they impose on their lenders. Because risk assessment techniques from the Basel II framework underlie our structural model, we can quantify the impact capital regulation and other government interventions have on bank leverage, firm leverage, and fragility. Deposit insurance and the expectation of government bailouts lead not only to risk taking by banks, but increased risk taking by firms. Capital regulation lowers bank leverage but can lead to compensating increases in the leverage of firms, as well as a small increase in borrowing costs.
Number of Pages in PDF File: 55
Keywords: Banks, capital structure, seniority, diversification, supply chains, deposit insurance, bailouts, capital regulation, Basel framework
JEL Classification: G18, G2, G21, G28, G32, G38working papers series
Date posted: October 31, 2013 ; Last revised: December 13, 2013
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