IDEAS home Printed from https://ideas.repec.org/a/ect/emjrnl/v2y1999i2p268-291.html
   My bibliography  Save this article

The optimal capital structure of a liquidity-insuring bank

Author

Listed:
  • HANS-JÜRG BÜTTLER

Abstract

This paper deals with the question of the optimal capital structure for a banking firm. It considers a competitive bank as an insurer of unpredictable liquidity demanded by depositors in the sense described by Diamond and Dybvig. The model developed in this paper is able to explain the stylized facts. It considers three key features of a bank: first, the demand deposit contract allows the depositor to run the bank if he believes that the bank?s solvency is insufficient. Secondly, four financial states of the shareholders? wealth are considered explicitly. Thirdly, the maximization of the shareholders? expected utility of pay-offs is constrained by the (weakest) condition that the expected yield on equity exceeds the risk-free rate of interest (the ?yield-on-equity constraint?). In the framework of our model, the unconstrained optima as considered in the existing banking literature imply, first, a high equity-to-debt ratio in the order of magnitude of 0.88 to 1 as well as a loan-to-cash ratio of one. Secondly, the bank is not exposed to any risk at all: it stays both solvent and liquid. When the ?yield-on-equity constraint? is taken into account, the constrained optimum may not be contained in the set of unconstrained optima if, for instance, the interest rate differential is small or if the volatility of changes in deposits is large. Such a constrained optimum implies, first, a low equity-to-debt ratio in the order of magnitude of 0.04 as well as a loan-to-cash ratio of one. Secondly, the bank is now exposed to the risk of an insolvency or an illiquidity.

Suggested Citation

  • Hans-Jürg Büttler, 1999. "The optimal capital structure of a liquidity-insuring bank," Econometrics Journal, Royal Economic Society, vol. 2(2), pages 268-291.
    • Handle: RePEc:ect:emjrnl:v:2:y:1999:i:2:p:268-291
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ect:emjrnl:v:2:y:1999:i:2:p:268-291. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley-Blackwell Digital Licensing or Christopher F. Baum (email available below). General contact details of provider: https://edirc.repec.org/data/resssea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.