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On flexibility, capital structure and investment decisions for the insured bank

Author

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  • Ritchken, Peter
  • Thomson, James B.
  • DeGennaro, Ramon P.
  • Li, Anlong

Abstract

Most models of deposit insurance assume that the volatility of a bank's assets is exogenously provided. Although this framework allows the impact of volatility on bankruptcy costs and deposit insurance subsidies to be explored, it is static and does not incorporate the fact that equityholders can respond to market events by adjusting previous investment and leverage decisions. This paper presents a dynamic model of a bank that allows for such behavior. The flexibility of being able to respond dynamically to market information has value to equityholders. The impact and value of this flexibility option are explored under a regime in which flat-rate deposit insurance is provided.
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Suggested Citation

  • Ritchken, Peter & Thomson, James B. & DeGennaro, Ramon P. & Li, Anlong, 1993. "On flexibility, capital structure and investment decisions for the insured bank," Journal of Banking & Finance, Elsevier, vol. 17(6), pages 1133-1146, December.
    • Handle: RePEc:eee:jbfina:v:17:y:1993:i:6:p:1133-1146
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    Cited by:

    1. DeYoung, Robert & Torna, Gökhan, 2013. "Nontraditional banking activities and bank failures during the financial crisis," Journal of Financial Intermediation, Elsevier, vol. 22(3), pages 397-421.
    2. Gropp, Reint & Vesala, Jukka & Vulpes, Giuseppe, 2006. "Equity and Bond Market Signals as Leading Indicators of Bank Fragility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 399-428, March.
    3. Robert R. Bliss, 2000. "The pitfalls in inferring risk from financial market data," Working Paper Series WP-00-24, Federal Reserve Bank of Chicago.
    4. Cole, Rebel A. & Gunther, Jeffery W., 1995. "Separating the likelihood and timing of bank failure," Journal of Banking & Finance, Elsevier, vol. 19(6), pages 1073-1089, September.
    5. Ivilina Popova & Peter H. Ritchken & James B. Thompson, 1995. "The changing role of banks and the changing value of deposit guarantees," Working Papers (Old Series) 9502, Federal Reserve Bank of Cleveland.
    6. Robert R. Bliss, 2001. "Market discipline and subordinated debt: a review of some salient issues," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 25(Q I), pages 24-45.
    7. David Marshall & Subu Venkataraman, 1999. "Bank Capital Standards for Market Risk: A Welfare Analysis," Review of Finance, European Finance Association, vol. 2(2), pages 125-157.
    8. Kane, Edward J., 1995. "Three paradigms for the role of capitalization requirements in insured financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 431-459, June.
    9. Panageas, Stavros, 2010. "Bailouts, the incentive to manage risk, and financial crises," Journal of Financial Economics, Elsevier, vol. 95(3), pages 296-311, March.
    10. Jacky So & Jason Z. Wei, 2004. "Deposit Insurance and Forbearance Under Moral Hazard," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 71(4), pages 707-735, December.
    11. Joseph G. Haubrich & James B. Thomson, 1994. "A conference on federal credit allocation," Economic Review, Federal Reserve Bank of Cleveland, vol. 30(Q III), pages 2-13.
    12. Park, Sangkyun & Peristiani, Stavros, 2007. "Are bank shareholders enemies of regulators or a potential source of market discipline?," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2493-2515, August.
    13. Angoua, Paul & Lai, Van Son & Soumare, Issouf, 2008. "Project risk choices under privately guaranteed debt financing," The Quarterly Review of Economics and Finance, Elsevier, vol. 48(1), pages 123-152, February.
    14. Rose Neng Lai & Robert Order, 2014. "Securitization, Risk-Taking and the Option to Change Strategy," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 42(2), pages 343-362, June.
    15. Park, Sangkyun, 1997. "Risk-taking behavior of banks under regulation," Journal of Banking & Finance, Elsevier, vol. 21(4), pages 491-507, April.
    16. Ramon P. DeGennaro & Larry H. Lang & James B. Thomson, 1991. "Troubled savings and loan institutions: voluntary restructuring under insolvency," Working Papers (Old Series) 9112, Federal Reserve Bank of Cleveland.
    17. Marc J. K. De Ceuster & Nancy Masschelein, 2003. "Regulating Banks through Market Discipline: A Survey of the Issues," Journal of Economic Surveys, Wiley Blackwell, vol. 17(5), pages 749-766, December.
    18. Anlong Li & Peter H. Ritchken & L. Sankarasubramanian & James B. Thomson, 1993. "Regulatory taxes, investment, and financing decision for insured banks," Working Papers (Old Series) 9303, Federal Reserve Bank of Cleveland.
    19. Horiuchi, Akiyoshi & Shimizu, Katsutoshi, 1998. "The deterioration of bank balance sheets in Japan: Risk-taking and recapitalization," Pacific-Basin Finance Journal, Elsevier, vol. 6(1-2), pages 1-26, May.
    20. Calem, Paul & Rob, Rafael, 1999. "The Impact of Capital-Based Regulation on Bank Risk-Taking," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 317-352, October.

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