Deposits and Bank Capital Structure
49 Pages Posted: 23 Mar 2013 Last revised: 24 May 2014
Date Written: May 12, 2014
In a model with bankruptcy costs and segmented deposit and equity markets, we endogenize the cost of equity and deposit finance for banks. Despite risk neutrality, equity capital earns a higher expected return than direct investment in risky assets. Banks hold positive capital to reduce bankruptcy costs, but there is a role for capital regulation when deposits are insured. Banks may no longer use capital when they lend to firms rather than invest directly in risky assets. This depends on whether the firms are public and compete with banks for equity capital, or private with exogenous amounts of capital.
Keywords: Deposit finance, bankruptcy costs, regulation
JEL Classification: G21, G32, G33
Suggested Citation: Suggested Citation