The Aggregate Demand for Bank Capital

Abstract

We propose a novel conceptual approach to transparently characterizing credit market outcomes in economies with multi-dimensional borrower heterogeneity. Based on characterizations of securities' implicit demand for bank equity capital, we obtain closed-form expressions for the composition of credit, including a sufficient statistic for the provision of bank loans, and a novel cross-sectional asset pricing relation for securities held by regulated levered institutions. Our framework sheds light on the compositional shifts in credit prior to the 07/08 financial crisis and the European debt crisis, and can provide guidance on the allocative effects of shocks affecting both banks and the cross-sectional distribution of borrowers.

Keywords: Bailouts, bank capital, Composition of credit, Credit rationing, Crowding out, Institutional asset pricing, Non-bank competition, Overinvestment

JEL Classification: G12, G21, G23, G28