Dynamic Banking and the Value of Deposits

Fisher College of Business Working Paper No. 2020-03-013

Charles A. Dice Working Paper No. 2020-13

37 Pages Posted: 10 Jun 2020 Last revised: 29 Oct 2020

See all articles by Patrick Bolton

Patrick Bolton

Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Ye Li

Ohio State University

Neng Wang

Columbia University; National Bureau of Economic Research (NBER); Asian Bureau of Finance and Economic Research (ABFER)

Jinqiang Yang

Columbia University; Shanghai University of Finance and Economics

Date Written: October 28, 2020

Abstract

We propose a dynamic theory of banking where deposits play the role of productive capital as in the classical Q-theory of investment for non-financial firms. A key conceptual innovation of our theory is that the stock of deposits cannot be perfectly controlled by the bank. Demand deposit accounts commit the bank to allow holders to withdraw or deposit funds at will. The resultant uncertainty in deposit flows exposes the bank to the risk of violating regulatory restrictions on leverage. Deposits create value for the bank except when it is close to hitting the leverage restrictions, because sudden deposit inflows can force the bank into costly equity issuance. We show that the bank is endogenously risk averse with respect to both the deposit flow risk and standard loan return risk. Our model predictions on dynamic bank valuation and asset-liability management are broadly consistent with the evidence. Moreover, our model lends itself to a quantitative evaluation of the costs and benefits of leverage regulations.

Keywords: Deposits, Dynamic Banking, Liquidity, Financial Constraint, Inside Money, Outside Money, Franchise Value, Payment System

JEL Classification: E4, E5, G21, G3

Suggested Citation

Bolton, Patrick and Li, Ye and Wang, Neng and Yang, Jinqiang, Dynamic Banking and the Value of Deposits (October 28, 2020). Fisher College of Business Working Paper No. 2020-03-013, Charles A. Dice Working Paper No. 2020-13, Available at SSRN: https://ssrn.com/abstract=3624119 or http://dx.doi.org/10.2139/ssrn.3624119

Patrick Bolton

Columbia Business School - Department of Economics ( email )

420 West 118th Street
New York, NY 10027
United States

HOME PAGE: http://www0.gsb.columbia.edu/faculty/pbolton/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Ye Li (Contact Author)

Ohio State University ( email )

Fisher Hall 836, 2100 Neil Ave
Columbus, OH 43210
United States

HOME PAGE: http://yeli-macrofinance.com

Neng Wang

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Asian Bureau of Finance and Economic Research (ABFER) ( email )

BIZ 2 Storey 4, 04-05
1 Business Link
Singapore, 117592
Singapore

Jinqiang Yang

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

Shanghai University of Finance and Economics ( email )

Law School, 777 Guoding Road, Yangpu District
Shanghai, AK 200433
China

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