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Competitive Bank Liability Design

Author

Listed:
  • Saki Bigio
  • Pierre-Olivier Weill
  • Diego Zúñiga

Abstract

We study how competitive banks design liabilities that function as money in an economy with asymmetric information. Assets differ in risk exposure, and sufficiently risky assets cannot circulate in decentralized trade. Banks commit to state-contingent payoffs and transform asset payoffs through bundling and tranching. In equilibrium, banks issue money as a liquid but risky liability that circulates in payments as well as an illiquid residual claim. Liquidity creation (i.e., money provision) relies on holding illiquid, risky assets and is enhanced by bundling safe and risky assets. Regulation of bank balance sheets should internalize these monetary provision and risk transformation roles.

Suggested Citation

  • Saki Bigio & Pierre-Olivier Weill & Diego Zúñiga, 2026. "Competitive Bank Liability Design," AEA Papers and Proceedings, American Economic Association, vol. 116, pages 426-432, May.
    • Handle: RePEc:aea:apandp:v:116:y:2026:p:426-432
    DOI: 10.1257/pandp.20261022
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Systems; Standards; Regimes; Government and the Monetary System
    • 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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