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http://ssrn.com/abstract=2347107
 
 

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Financing as a Supply Chain: The Capital Structure of Banks and Borrowers


Will Gornall


Stanford Graduate School of Business

Ilya A. Strebulaev


Stanford University - Graduate School of Business; National Bureau of Economic Research

April 4, 2014

Rock Center for Corporate Governance at Stanford University Working Paper No. 166

Abstract:     
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 can offer the lowest interest rates. Low asset volatility enables banks to take on high leverage safely; 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 framework underlie our model, we can quantify the impact capital regulation and other government interventions have on leverage and fragility. Deposit insurance and the expectation of government bailouts increase not only bank risk taking, but also borrower risk taking. Capital regulation lowers bank leverage but can lead to compensating increases in the leverage of borrowers, which can paradoxically lead to riskier banks. Doubling current capital requirements would reduce the default risk of banks exposed to high moral hazard by up to 90%, with only a small increase in bank interest rates.

Number of Pages in PDF File: 50

Keywords: Banks, capital structure, seniority, diversification, supply chains, deposit insurance, bailouts, capital regulation, Basel framework

JEL Classification: G18, G2, G21, G28, G32, G38

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Date posted: October 31, 2013 ; Last revised: April 5, 2014

Suggested Citation

Gornall, Will and Strebulaev, Ilya A., Financing as a Supply Chain: The Capital Structure of Banks and Borrowers (April 4, 2014). Rock Center for Corporate Governance at Stanford University Working Paper No. 166. Available at SSRN: http://ssrn.com/abstract=2347107 or http://dx.doi.org/10.2139/ssrn.2347107

Contact Information

Will Gornall
Stanford Graduate School of Business ( email )
518 Memorial Way
Stanford, CA 94305-5015
United States
HOME PAGE: http://stanford.edu/~gornall/
Ilya A. Strebulaev (Contact Author)
Stanford University - Graduate School of Business ( email )
655 Knight Way
Stanford, CA 94305-5015
United States
HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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