[go: up one dir, main page]
IDEAS home Printed from https://ideas.repec.org/p/bon/boncrc/crctr224_2024_605.html
   My bibliography  Save this paper

Optimal Banking Arrangements: Liquidity Creation Without Financial Fragility

Author

Listed:
  • Maxi Günnewig
  • Yuliyan Mitkov
Abstract
Diamond and Rajan (2000, 2001) argue that banks create liquidity by issuing deposits to fund difficult, illiquid firms that otherwise cannot obtain funding. Since deposits may lead to bank runs, this resulting financial fragility is essential for liquidity creation. We revisit the Diamond-Rajan model of financial intermediation and show that a bank with an optimal financing structure is not subject to runs. Our contract rests on three simple notions. First, each bank creditor has the right to demand repayment at every instant. Second, the repayment is given by the value of a pre- specified fraction of the bank’s assets. Third, some creditors are more senior than others: their repayment demands are prioritized. In contrast to Diamond and Rajan, we find that financial fragility is detrimental to liquidity creation.

Suggested Citation

  • Maxi Günnewig & Yuliyan Mitkov, 2024. "Optimal Banking Arrangements: Liquidity Creation Without Financial Fragility," CRC TR 224 Discussion Paper Series crctr224_2024_605, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2024_605
    as

    Download full text from publisher

    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp605
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. George Pennacchi & Alexei Tchistyi, 2019. "On Equilibrium When Contingent Capital Has a Market Trigger: A Correction to Sundaresan and Wang Journal of Finance (2015)," Journal of Finance, American Finance Association, vol. 74(3), pages 1559-1576, June.
    2. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December.
    3. Sudheer Chava & Michael R. Roberts, 2008. "How Does Financing Impact Investment? The Role of Debt Covenants," Journal of Finance, American Finance Association, vol. 63(5), pages 2085-2121, October.
    4. Dávila, Eduardo & Walther, Ansgar, 2020. "Does size matter? Bailouts with large and small banks," Journal of Financial Economics, Elsevier, vol. 136(1), pages 1-22.
    5. Keister, Todd & Mitkov, Yuliyan, 2023. "Allocating losses: Bail-ins, bailouts and bank regulation," Journal of Economic Theory, Elsevier, vol. 210(C).
    6. Oliver Hart & John Moore, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 109(4), pages 841-879.
    7. Mitkov, Yuliyan, 2024. "A theory of debt maturity and innovation," Journal of Economic Theory, Elsevier, vol. 218(C).
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Giovanni Dell’Ariccia & Dalida Kadyrzhanova & Camelia Minoiu & Lev Ratnovski, 2021. "Bank Lending in the Knowledge Economy," The Review of Financial Studies, Society for Financial Studies, vol. 34(10), pages 5036-5076.
    2. Hans Gersbach & Jean-Charles Rochet & Martin Scheffel, 2016. "Taking Banks to Solow," International Economic Association Series, in: Joseph E. Stiglitz & Martin Guzman (ed.), Contemporary Issues in Macroeconomics, chapter 13, pages 176-198, Palgrave Macmillan.
    3. Hajime Tomura, 2010. "Liquidity Transformation and Bank Capital Requirements," Staff Working Papers 10-22, Bank of Canada.
    4. Hans Gersbach & Jean-Charles Rochet & Martin Scheffel, 2023. "Financial Intermediation, Capital Accumulation, and Crisis Recovery," Review of Finance, European Finance Association, vol. 27(4), pages 1423-1469.
    5. Giang Phung & Michael Troege, 2024. "Making depositors greedy and careless: Government safety nets and the degradation of depositor discipline," Economics of Transition and Institutional Change, John Wiley & Sons, vol. 32(3), pages 921-947, July.
    6. Marc Arnold & Dirk Hackbarth & Tatjana Xenia Puhan, 2018. "Financing Asset Sales and Business Cycles [Does industry-wide distress affect defaulted firms? Evidence from creditor recoveries]," Review of Finance, European Finance Association, vol. 22(1), pages 243-277.
    7. S. Viswanathan & Adriano A. Rampini, 2008. "Collateral, Financial Intermediation, and the Distribution of Debt Capacity," 2008 Meeting Papers 116, Society for Economic Dynamics.
    8. Benmelech, Efraim & Kumar, Nitish & Rajan, Raghuram, 2022. "The secured credit premium and the issuance of secured debt," Journal of Financial Economics, Elsevier, vol. 146(1), pages 143-171.
    9. Rochet, Jean Charles & Gersbach, Hans & Scheffel, Martin, 2015. "Financial Intermediation, Capital Accumulation, and Recovery," CEPR Discussion Papers 10964, C.E.P.R. Discussion Papers.
    10. Diamond, Douglas W. & Hu, Yunzhi & Rajan, Raghuram G., 2022. "Liquidity, pledgeability, and the nature of lending," Journal of Financial Economics, Elsevier, vol. 143(3), pages 1275-1294.
    11. Jason Donaldson & Denis Gromb & Giorgia Piacentino, 2019. "Conflicting Priorities: A Theory of Covenants and Collateral," 2019 Meeting Papers 157, Society for Economic Dynamics.
    12. Diamond, Douglas W. & Rajan, Raghuram G., 2001. "Banks, short-term debt and financial crises: theory, policy implications and applications," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 54(1), pages 37-71, June.
    13. Engelberg, Joseph & Gao, Pengjie & Parsons, Christopher A., 2012. "Friends with money," Journal of Financial Economics, Elsevier, vol. 103(1), pages 169-188.
    14. Douglas W. Diamond & Raghuram G. Rajan, 2005. "Liquidity Shortages and Banking Crises," Journal of Finance, American Finance Association, vol. 60(2), pages 615-647, April.
    15. Alan D. Morrison & Ansgar Walther, 2020. "Market Discipline and Systemic Risk," Management Science, INFORMS, vol. 66(2), pages 764-782, February.
    16. Goetz von Peter, 2003. "A Unified Approach to Credit Crunches, Financial Instability, and Banking Crises," Macroeconomics 0312006, University Library of Munich, Germany.
    17. Lee, Edward & Pappas, Kostas & Xu, Alice Liang, 2020. "Foreign Lenders’ adoption of performance pricing provisions in syndicated loans," Journal of Banking & Finance, Elsevier, vol. 118(C).
    18. Brian Akins & David De Angelis & Maclean Gaulin, 2020. "Debt Contracting on Management," Journal of Finance, American Finance Association, vol. 75(4), pages 2095-2137, August.
    19. Nikolaev, Valeri V., 2018. "Scope for renegotiation in private debt contracts," Journal of Accounting and Economics, Elsevier, vol. 65(2), pages 270-301.
    20. Diemo Dietrich & Uwe Vollmer, 2010. "International Banking and Liquidity Allocation," Journal of Financial Services Research, Springer;Western Finance Association, vol. 37(1), pages 45-69, February.

    More about this item

    Keywords

    Liquidity; banking; financial fragility; optimal contracts; collateral.;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bon:boncrc:crctr224_2024_605. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: CRC Office (email available below). General contact details of provider: https://www.crctr224.de .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.