Year: 2000
Type: article
Abstract: Banks can create liquidity precisely because deposits are fragile and prone to runs. Increased uncertainty makes deposits excessively fragile, creating a role for outside bank capital. Greater bank capital reduces the probability of financial distress but also reduces liquidity creation. The quantity of capital influences the amount that banks can induce borrowers to pay. Optimal bank capital structure trades off effects on liquidity creation, costs of bank distress, and the ability to force borrower repayment. The model explains the decline in bank capital over the last two centuries. It identifies overlooked consequences of having regulatory capital requirements and deposit insurance.
Source: The Journal of Finance
Authors: Douglas W. Diamond, Raghuram G. Rajan
Institutions: National Bureau of Economic Research, University of Chicago
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: bronze
Funder: National Science Foundation
OpenAlex ID: W3125521824