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Bankruptcy Priority for Bank Deposits: A Contract Theoretic Explanation

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  • Birchler, Urs W

Abstract

Over the past decade several countries, including the US, have introduced or redesigned legislation that confers priority in bankruptcy upon all or some bank deposits. We argue that in the presence of contracting costs such rules can increase efficiency. We first show in a private information model that a borrower can reduce overall costs of finance by letting informationally heterogeneous lenders choose between junior and senior debt. In particular, we find that debt priorities reduce socially wasteful information gathering by investors. We then argue why, particularly in banking, legal standardization of debt priorities may be superior to bilateral private arrangements. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Birchler, Urs W, 2000. "Bankruptcy Priority for Bank Deposits: A Contract Theoretic Explanation," The Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 813-840.
    • Handle: RePEc:oup:rfinst:v:13:y:2000:i:3:p:813-40
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    Cited by:

    1. Kevin Davis, 2020. "Regulatory changes to bank liability structures: implications for deposit insurance design," Journal of Banking Regulation, Palgrave Macmillan, vol. 21(1), pages 95-106, March.
    2. Urs W. Birchler, 2000. "Are banks excessively monitored?," Working Papers 00.14, Swiss National Bank, Study Center Gerzensee.
    3. Urs W. Birchler & Diana Hancock, 2003. "What does the yield on subordinated bank debt measure?," Finance and Economics Discussion Series 2004-19, Board of Governors of the Federal Reserve System (U.S.).
    4. Henri Pagès & Joao A.C. Santos, 2002. "Optimal Supervisory Policies and Depositor-Preferences Laws," Working papers 91, Banque de France.
    5. Luis-Javier Vásquez-Serpa & Ciro Rodríguez & Jhelly-Reynaluz Pérez-Núñez & Carlos Navarro, 2025. "Challenges of Artificial Intelligence for the Prevention and Identification of Bankruptcy Risk in Financial Institutions: A Systematic Review," JRFM, MDPI, vol. 18(1), pages 1-34, January.
    6. Thaer Alhalabi & Vítor Castro & Justine Wood, 2023. "Bank dividend payout policy and debt seniority: Evidence from US Banks," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 32(5), pages 285-340, December.
    7. Francis, Bill & Hasan, Iftekhar & Liu, LiuLing & Wang, Haizhi, 2019. "Senior debt and market discipline: Evidence from bank-to-bank loans," Journal of Banking & Finance, Elsevier, vol. 98(C), pages 170-182.
    8. Garcia-Appendini, Emilia & Gatti, Stefano & Nocera, Giacomo, 2023. "Does asset encumbrance affect bank risk? Evidence from covered bonds," Journal of Banking & Finance, Elsevier, vol. 146(C).
    9. Kahn, Charles M. & Santos, Joao A.C., 2005. "Allocating bank regulatory powers: Lender of last resort, deposit insurance and supervision," European Economic Review, Elsevier, vol. 49(8), pages 2107-2136, November.
    10. Eboli, Mario, 2025. "Systemic risk in centralised interbank networks," Journal of Financial Stability, Elsevier, vol. 81(C).
    11. Spiros Bougheas & Alan Kirman, 2018. "Systemic risk and the optimal seniority structure of banking liabilities," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 23(1), pages 47-54, January.
    12. Spiros Bougheas & Alan Kirman, 2016. "Bank Insolvencies, Priority Claims and Systemic Risk," Lecture Notes in Economics and Mathematical Systems, in: Pasquale Commendatore & Mariano Matilla-García & Luis M. Varela & Jose S. Cánovas (ed.), Complex Networks and Dynamics, pages 195-208, Springer.
    13. Douglas Cumming & Hisham Farag & Santosh Koirala & Danny McGowan, 2026. "How Disruptive is Financial Technology?," Papers 2601.14071, arXiv.org, revised Jan 2026.
    14. Marvin Goodfriend & Jeffrey M. Lacker, 1999. "Limited commitment and central bank lending," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-27.
    15. Piotr Danisewicz & Danny McGowan & Enrico Onali & Klaus Schaeck, 2018. "Debt Priority Structure, Market Discipline, and Bank Conduct," The Review of Financial Studies, Society for Financial Studies, vol. 31(11), pages 4493-4555.

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