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Banks as Patient Fixed Income Investors

  • Hanson, Samuel

    (Harvard University)

  • Shleifer, Andrei

    (Harvard University)

  • Stein, Jeremy C.

    ()

    (Board of Governors of the Federal Reserve System (U.S.))

  • Vishny, Robert W.

    (University of Chicago)

We examine the business model of traditional commercial banks in the context of their co-existence with shadow banks. While both types of intermediaries create safe "money-like" claims, they go about this in very different ways. Traditional banks create safe claims with a combination of costly equity capital and fixed income assets that allows their depositors to remain "sleepy": they do not have to pay attention to transient fluctuations in the mark-to-market value of bank assets. In contrast, shadow banks create safe claims by giving their investors an early exit option that allows them to seize collateral and liquidate it at the first sign of trouble. Thus traditional banks have a stable source of cheap funding, while shadow banks are subject to runs and fire-sale losses. These different funding models in turn influence the kinds of assets that traditional banks and shadow banks hold in equilibrium: traditional banks have a comparative advantage at holding fixed-income assets that have only modest fundamental risk, but are relatively illiquid and have substantial transitory price volatility.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2014-15.

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Length: 49 pages
Date of creation: 10 Feb 2014
Date of revision:
Handle: RePEc:fip:fedgfe:2014-15
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  1. Douglas W. Diamond & Raghuram G. Rajan, 1999. "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," NBER Working Papers 7430, National Bureau of Economic Research, Inc.
  2. Bengt Holmström & Jean Tirole, 2011. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262015781, June.
  3. Harry DeAngelo & René M. Stulz, 2013. "Why High Leverage is Optimal for Banks," NBER Working Papers 19139, National Bureau of Economic Research, Inc.
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  5. Ben S. Bernanke, 2005. "The global saving glut and the U.S. current account deficit," Speech 77, Board of Governors of the Federal Reserve System (U.S.).
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  8. John H. Cochrane, 2011. "Presidential Address: Discount Rates," Journal of Finance, American Finance Association, vol. 66(4), pages 1047-1108, 08.
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  16. repec:fip:fedgsq:y:2005:i:mar10 is not listed on IDEAS
  17. Alan Moreira & Alexi Savov, 2014. "The Macroeconomics of Shadow Banking," NBER Working Papers 20335, National Bureau of Economic Research, Inc.
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  20. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, Oxford University Press, vol. 127(1), pages 57-95.
  21. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  22. Gary Gorton & Andrew Metrick, 2010. "Regulating the Shadow Banking System," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 41(2 (Fall)), pages 261-312.
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