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Deposits and Bank Capital Structure

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  • 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. JEL Codes: G21, G32, G33 Keywords: Deposit finance, bankruptcy costs, bank diversification

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 477.

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Date of creation: 2013
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Handle: RePEc:igi:igierp:477

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  1. Fenghua Song & Anjan V. Thakor, 2007. "Relationship Banking, Fragility, and the Asset-Liability Matching Problem," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 2129-2177, November.
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Cited by:
  1. Harry DeAngelo & René M. Stulz, 2013. "Why High Leverage is Optimal for Banks," NBER Working Papers 19139, National Bureau of Economic Research, Inc.

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