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

62 Pages Posted: 10 Jun 2020 Last revised: 13 Jul 2021

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 Business School - Finance and Economics; National Bureau of Economic Research (NBER); Asian Bureau of Finance and Economic Research (ABFER)

Jinqiang Yang

Columbia University; Shanghai University of Finance and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: July 12, 2021

Abstract

We propose a dynamic theory of banking where the role of deposits is akin to that of productive capital in the classical Q-theory of investment for non-financial firms. As a key source of leverage, deposits create value for well-capitalized banks. However, unlike productive capital of nonfinancial firms that typically has a positive marginal q, the deposit marginal q can turn negative for undercapitalized banks. Demand deposit accounts commit banks to allow holders to withdraw or deposit funds at will, so banks cannot perfectly control leverage. Therefore, for banks with insufficient equity capital to buffer risk, deposit inflows and the associated uncertainty in future leverage can destroy value. Our model predictions on bank valuation and dynamic asset-liability management are broadly consistent with the evidence. Moreover, our model lends itself to a re-evaluation of the costs and benefits of leverage regulation and offers new perspectives on the challenges that banks face in a low interest rate environment.

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 (July 12, 2021). 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)

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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 Business School - Finance and Economics ( 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 )

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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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