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Insecure Debt

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  • Perotti, Enrico
  • Matta, Rafael

Abstract

We study bank funding choices under asset liquidity risk and a realistic bankruptcy process, where illiquid assets are shared among all unpaid creditors. Repo debt is cheap and stable but shifts risk to unsecured debt. In the unique equilibrium, repo has a nonmonotonic effect. Runs are rare when unpledged liquid assets are abundant, rise as more repo funding shifts risk, and ultimately fall as less liquidity is available for early withdrawals. The socially optimal choice minimizes inefficient runs by limiting repo or by subsidizing a high rollover yield on unsecured debt. The private choice uses more repo and a lower rollover reward, trading off runs against cheaper funding

Suggested Citation

  • Perotti, Enrico & Matta, Rafael, 2015. "Insecure Debt," CEPR Discussion Papers 10505, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:10505
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    Cited by:

    1. Ahnert, Toni & Anand, Kartik & Gai, Prasanna & Chapman, James, 2015. "Safe, or not safe? Covered bonds and Bank Fragility," VfS Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 112875, Verein für Socialpolitik / German Economic Association.
    2. Anil K. Kashyap & Dimitrios P. Tsomocos & Alexandros Vardoulakis, 2017. "Optimal Bank Regulation in the Presence of Credit and Run Risk," Finance and Economics Discussion Series 2017-097, Board of Governors of the Federal Reserve System (U.S.).
    3. Schilling, Linda, 2017. "Optimal Forbearance of Bank Resolution," MPRA Paper 112409, University Library of Munich, Germany.
    4. Leonello, Agnese, 2018. "Government guarantees and the two-way feedback between banking and sovereign debt crises," Journal of Financial Economics, Elsevier, vol. 130(3), pages 592-619.
    5. Okahara, Naoto, 2020. "Liquidity requirement and banks' lending," MPRA Paper 101816, University Library of Munich, Germany.
    6. Toni Ahnert & Kartik Anand & Prasanna Gai & James Chapman & Philip StrahanEditor, 2019. "Asset Encumbrance, Bank Funding, and Fragility," Review of Financial Studies, Society for Financial Studies, vol. 32(6), pages 2422-2455.

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    More about this item

    Keywords

    Bank runs; Haircuts; Repo; Secured credit;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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