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Moral hazard and debt maturity

Author

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  • Huberman, Gur
  • Repullo, Rafael

Abstract

We present a model of the maturity of a bank’s uninsured debt. The bank borrows funds and chooses afterwards the riskiness of its assets. This moral hazard problem leads to an excessive level of risk. Short-term debt may have a disciplining effect on the bank’s risk-shifting incentives, but it may lead to inefficient liquidation. We characterize the conditions under which short-term and long-term debt are feasible, and show circumstances under which only short-term debt is feasible and under which short-term debt dominates long-term debt when both are feasible. Thus, short-term debt may have the salutary effect of mitigating the moral hazard problem and inducing lower risk-taking. The results are consistent with key features of the common narrative of the period preceding the 2007-2009 financial crisis.

Suggested Citation

  • Huberman, Gur & Repullo, Rafael, 2014. "Moral hazard and debt maturity," LSE Research Online Documents on Economics 59294, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:59294
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    File URL: https://researchonline.lse.ac.uk/id/eprint/59294/
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    Cited by:

    1. Ala'a Adden Awni Abuhommous, 2025. "Does the firm's life cycle matter in the relationship between short‐term debt and investment efficiency?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 30(2), pages 1429-1449, April.
    2. Zhou, Yimin & Wei, Xu, 2023. "Bond liquidity, debt maturity and bond risk premium," Finance Research Letters, Elsevier, vol. 54(C).
    3. Zou, Jingxian & Shen, Guangjun & Gong, Yaxian, 2019. "The effect of value-added tax on leverage: Evidence from China’s value-added tax reform," China Economic Review, Elsevier, vol. 54(C), pages 135-146.
    4. Leng, Dong & Wei, Xu & Zhuo, Yilin, 2024. "Belief disagreement and debt maturity structure," Economics Letters, Elsevier, vol. 243(C).
    5. Wei, Xu & Xiao, Xiao & Zhou, Yi & Zhou, Yimin, 2023. "Spillover effects between liquidity risks through endogenous debt maturity," Journal of Financial Markets, Elsevier, vol. 64(C).
    6. Gong, Yaxian & Wei, Xu, 2019. "Asset quality, debt maturity, and market liquidity," Finance Research Letters, Elsevier, vol. 31(C).
    7. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95, May.
    8. Wei, Xu & Gong, Yaxian & Wu, Ho-Mou, 2017. "The impacts of Net Stable Funding Ratio requirement on Banks’ choices of debt maturity," Journal of Banking & Finance, Elsevier, vol. 82(C), pages 229-243.
    9. Renata Karkowska & Paweł Niedziółka, 2019. "Rentowność banków komercyjnych a ich płynność w kontekście implementacji ilościowych norm płynności rekomendowanych przez Bazylejski Komitet ds. Nadzoru Bankowego," Bank i Kredyt, Narodowy Bank Polski, vol. 50(2), pages 149-172.
    10. Gong, Yaxian & Wei, Xu, 2022. "Asset quality, financing structure, and bank regulations," International Review of Economics & Finance, Elsevier, vol. 80(C), pages 1061-1075.

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    Keywords

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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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