Safe Assets and Dangerous Liabilities: How Bank-Level Frictions Explain Bank Seniority
68 Pages Posted: 19 Nov 2014 Last revised: 29 Apr 2018
Date Written: April 20, 2018
This paper uses bank fragility to explain why bank loans are senior in firm capital structure. High leverage makes banks more vulnerable to financial distress than the typical bond investor, and thus makes banks willing to pay for seniority. Bank seniority emerges even when banks need skin in the game, as bank effort has more impact on a large senior loan than on a smaller junior claim with the same systematic risk. Adding deposit insurance or bailouts adds a subsidy to tail risk, which makes large senior claims even more attractive to banks. Empirically, this model explains why procyclical firms avoid bank loans and provides a host of debt structure predictions.
Keywords: Seniority, debt structure, banks, financial intermediaries, capital structure
JEL Classification: G2, G21, G23, G28, G3, G32, G33, G38
Suggested Citation: Suggested Citation