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Bankruptcy Priority for Bank Deposits: a Contract Theoretic Explanation

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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.

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  • Urs W. Birchler, 1999. "Bankruptcy Priority for Bank Deposits: a Contract Theoretic Explanation," Working Papers 00.01, Swiss National Bank, Study Center Gerzensee.
  • Handle: RePEc:szg:worpap:0001
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    Cited by:

    1. 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.).
    2. Pagès, H. & Santos, J., 2002. "Optimal Supervisory Policies and Depositor-Preferences Laws," Working papers 91, Banque de France.
    3. Marvin Goodfriend & Jeffrey M. Lacker, 1999. "Limited commitment and central bank lending," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-27.
    4. Spiros Bougheas & Alan Kirman, 2015. "Bank Insolvencies, Priority Claims and Systemic Risk," Discussion Papers 2015/08, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    5. 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.
    6. Urs W. Birchler, 2000. "Are banks excessively monitored?," Working Papers 00.14, Swiss National Bank, Study Center Gerzensee.

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