Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/204695
Authors: 
Admati, Anat R.
Hellwig, Martin
Year of Publication: 
2018
Series/Report no.: 
Discussion Papers of the Max Planck Institute for Research on Collective Goods 2018/13
Abstract: 
We take issue with claims that the funding mix of banks, which makes them fragile and crisisprone, is efficient because it reflects special liquidity benefits of bank debt. Even aside from neglecting the systemic damage to the economy that banks' distress and default cause, such claims are invalid because banks have multiple small creditors and are unable to commit effectively to their overall funding mix and investment strategy ex ante. The resulting market outcomes under laissez-faire are inefficient and involve excessive borrowing, with default risks that jeopardize the purported liquidity benefits. Contrary to claims in the literature that "equity is expensive" and that regulation requiring more equity in the funding mix entails costs to society, such regulation actually helps create useful commitment for banks to avoid the inefficiently high borrowing that comes under laissez-faire. Effective regulation is beneficial even without considering systemic risk; if such regulation also reduces systemic risk, the benefits are even larger.
Subjects: 
Liquidity in banking
leverage in banking
banking regulation
capital structure
capital regulations
agency costs
commitment
contracting
maturity rat race
leverage ratchet effect
Basel
JEL: 
D04
D53
D61
G01
G18
G21
G24
G28
G32
G38
H81
K23
Document Type: 
Working Paper
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