Bank Capital and the Modigliani-Miller Theorem When Loans Create Deposits

26 Pages Posted: 28 Mar 2019 Last revised: 9 Nov 2020

See all articles by George Dotsis

George Dotsis

National and Kapodistrian University of Athens - Faculty of Economics; Essex Finance Centre, Essex Business School, University of Essex

Date Written: November 10, 2020

Abstract

This paper argues that banks should not be treated as intermediaries of loanable funds in order to determine optimal bank capital structure. This is because banks create deposits through the process of lending. The Modigliani–Miller analysis cannot be applied to banks because when lending creates deposits the asset side of banks varies together with the liability side and equity behaves more like a sticky variable. In this setting, aggregate procyclical high leverage in the banking sector emerges almost automatically. The paper provides some empirical evidence consistent with this view and discusses implications with respect to bank regulation.

Keywords: bank capital, Modigliani–Miller, loans create deposits

JEL Classification: G21, G32

Suggested Citation

Dotsis, George, Bank Capital and the Modigliani-Miller Theorem When Loans Create Deposits (November 10, 2020). Available at SSRN: https://ssrn.com/abstract=3347104 or http://dx.doi.org/10.2139/ssrn.3347104

George Dotsis (Contact Author)

National and Kapodistrian University of Athens - Faculty of Economics ( email )

Greece

HOME PAGE: http://sites.google.com/site/gdotsis/

Essex Finance Centre, Essex Business School, University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

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