Unstable Banking

46 Pages Posted: 12 May 2009 Last revised: 4 Aug 2010

See all articles by Andrei Shleifer

Andrei Shleifer

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Robert W. Vishny

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2009

Abstract

We propose a theory of financial intermediaries operating in markets influenced by investor sentiment. In our model, banks make loans, securitize these loans, trade in them, or hold cash. They can also borrow money, using their security holdings as collateral. We embed such banks in a stylized financial market, in which securitized loans may be mispriced, and investigate how banks allocate limited capital among the various activities, as well as how they choose their capital structure. Banks maximize profits, and there are no conflicts of interest between bank shareholders and creditors. The theory explains the cyclical behavior of credit and investment, but also accounts for the fundamental instability of banks operating in financial markets, especially when banks use leverage.

Suggested Citation

Shleifer, Andrei and Vishny, Robert W., Unstable Banking (May 2009). NBER Working Paper No. w14943. Available at SSRN: https://ssrn.com/abstract=1401788

Andrei Shleifer (Contact Author)

Harvard University - Department of Economics ( email )

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HOME PAGE: http://www.economics.harvard.edu/~ashleife/

National Bureau of Economic Research (NBER)

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European Corporate Governance Institute (ECGI)

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Robert W. Vishny

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
United States
312-702-2522 (Phone)
312-702-0118 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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