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Safe Assets and Dangerous Liabilities: How Bank-Level Frictions Explain Bank Seniority

66 Pages Posted: 19 Nov 2014 Last revised: 24 Dec 2015

Will Gornall

University of British Columbia (UBC) - Sauder School of Business

Date Written: December 1, 2015

Abstract

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

Gornall, Will, Safe Assets and Dangerous Liabilities: How Bank-Level Frictions Explain Bank Seniority (December 1, 2015). Available at SSRN: https://ssrn.com/abstract=2526574 or http://dx.doi.org/10.2139/ssrn.2526574

Will Gornall (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

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