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Optimal Intermediary Contracts

Author

Listed:
  • Nabi Arjmandi

    (Department of Economics, University of Missouri-Columbia)

  • Chao Gu

    (Department of Economics, University of Missouri-Columbia)

  • Joseph H. Haslag

    (Department of Economics, University of Missouri-Columbia)

Abstract

Financial intermediaries simultaneously engage in two separate relationships: they accept deposits and they make loans. Yet, researchers have focused either on deposit contracts or loan contracts. In this paper, we develop a theory in which deposit contracts and loan contracts are determined in equilibrium. Borrowers have limited commitment and the banks have access to a direct, safe long-term investment. We then study how changes in the borrower’s creditworthiness affects deposit and loan contracts. We study this relationship across different trading protocols. With deteriorating credit conditions, we find that loan rates can decline (declining spreads) and loan quantities can increase. This is the opposite direction used when constructing things like credit indicators. This relationship is not robust to changes in market structures. Lastly, we show how an aggregate fundamental shock can induce bank runs. However, the bank run is less likely in the worst credit-condition category.

Suggested Citation

  • Nabi Arjmandi & Chao Gu & Joseph H. Haslag, 2022. "Optimal Intermediary Contracts," Working Papers 2209, Department of Economics, University of Missouri.
    • Handle: RePEc:umc:wpaper:2209
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    More about this item

    Keywords

    deposit contracts; loan contracts; credit conditions; financial indicators;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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