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Does Debt Discipline Bankers? An Academic Myth about Bank Indebtedness

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  • Anat Admati
  • Martin Hellwig

Abstract

Supplementing the discussion in our book The Bankers' New Clothes: What's Wrong with Banking and What to Do About It, this paper examines the plausibility and relevance of claims in banking theory that fragility of bank funding is useful because it imposes discipline on bank managers. The assumptions about information and about costs of bank breakdowns underlying these claims are unrealistic and they cannot be generalized without undermining the theory and policy prescriptions. The discipline narrative is also incompatible with the view that deposits and other forms of short-term bank debt contribute to liquidity provision; in this liquidity narrative, fragility of banks are a by-product of useful liquidity provision and can only be avoided by government support. We contrast both narratives with an explanation for banks' avoidance of equity and reliance on short-term debt that appeals to debt overhang and government guarantees and subsidies for debt. In this explanation, fragility of banks arises from a conflict of interest and is neither useful for society nor unavoidable.

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Paper provided by Institute for New Economic Thinking (INET) in its series INET Research Notes with number 24.

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Date of creation: 12 Feb 2013
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Handle: RePEc:thk:rnotes:24

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  1. Viral V. Acharya & Philipp Schnabl & Gustavo Suarez, 2010. "Securitization without risk transfer," NBER Working Papers 15730, National Bureau of Economic Research, Inc.
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  5. Calomiris, Charles W., 1999. "Building an incentive-compatible safety net," Journal of Banking & Finance, Elsevier, Elsevier, vol. 23(10), pages 1499-1519, October.
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  7. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository, ULB -- Universite Libre de Bruxelles 2013/9539, ULB -- Universite Libre de Bruxelles.
  8. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(3), pages 401-19, June.
  9. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780199734153, October.
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Cited by:
  1. Philipp König & David Pothier, 2014. "Asymmetric Information and Roll-Over Risk," Discussion Papers of DIW Berlin 1364, DIW Berlin, German Institute for Economic Research.

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