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Bank capital structure and credit decisions

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  • Inderst, Roman
  • Mueller, Holger M.

Abstract

This paper argues that banks must be sufficiently levered to have first-best incentives to make new risky loans. This result, which is at odds with the notion that leverage invariably leads to excessive risk taking, derives from two key premises that focus squarely on the role of banks as informed lenders. First, banks finance projects that they do not own, which implies that they cannot extract all the profits. Second, banks conduct a credit risk analysis before making new loans. Our model may help understand why banks take on additional unsecured debt, such as unsecured deposits and subordinated loans, over and above their existing deposit base. It may also help understand why banks and finance companies have similar leverage ratios, even though the latter are not deposit takers and hence not subject to the same regulatory capital requirements as banks.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Intermediation.

Volume (Year): 17 (2008)
Issue (Month): 3 (July)
Pages: 295-314

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Handle: RePEc:eee:jfinin:v:17:y:2008:i:3:p:295-314

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Web page: http://www.elsevier.com/locate/inca/622875

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References

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  1. Manove, Michael & Padilla, Atilano Jorge & Pagano, Marco, 2000. "Collateral Vs. Project Screening: A Model Of Lazy Banks," CEPR Discussion Papers 2439, C.E.P.R. Discussion Papers.
  2. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  3. Inderst, Roman & Mueller, Holger M, 2005. "Informed Lending and Security Design," CEPR Discussion Papers 5185, C.E.P.R. Discussion Papers.
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  9. Manove, Michael & Padilla, A Jorge & Pagano, Marco, 2001. "Collateral versus Project Screening: A Model of Lazy Banks," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 726-44, Winter.
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Citations

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Cited by:
  1. Belkhir, Mohamed, 2013. "Do subordinated debt holders discipline bank risk-taking? Evidence from risk management decisions," Journal of Financial Stability, Elsevier, vol. 9(4), pages 705-719.
  2. Olivier Bruno & André Cartapanis & Eric Nasica, 2013. "Bank leverage, financial fragility and prudential regulation," Working Papers halshs-00853701, HAL.
  3. Eufinger, Christian & Gill, Andrej, 2013. "Basel III and CEO compensation in banks: Pay structures as a regulatory signal," SAFE Working Paper Series 9, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.

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