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Deposits and Bank Capital Structure

Author

Listed:
  • Franklin Allen
  • Elena Carletti
Abstract
In a model with bankruptcy costs and segmented deposit and equity markets, we endogenize the choice of bank and firm capital structure and the cost of equity and deposit finance. Despite risk neutrality, equity capital is more costly than deposits. When banks directly finance risky investments, they hold positive capital and diversify. When they make risky loans to firms, banks trade off the high cost of equity with the diversification benefits from a lower bankruptcy probability. When bankruptcy costs are high, banks use no capital and only lend to one sector. When these are low, banks hold capital and diversify.

Suggested Citation

  • Franklin Allen & Elena Carletti, 2013. "Deposits and Bank Capital Structure," Economics Working Papers ECO2013/03, European University Institute.
  • Handle: RePEc:eui:euiwps:eco2013/03
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    References listed on IDEAS

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    More about this item

    Keywords

    Deposit finance; bankruptcy costs; bank diversification;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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