Bank capital structure and credit decisions

Arbeitspapier

This paper argues that banks must be sufficiently levered to have first-best incentives to make new risky loans. This result, which is at odds with the notion that leverage invariably leads to excessive risk taking, derives from two key premises that focus squarely on the role of banks as informed lenders. First, banks finance projects that they do not own, which implies that they cannot extract all the profits. Second, banks conduct a credit risk analysis before making new loans. Our model may help understand why banks take on additional unsecured debt, such as unsecured deposits and subordinated loans, over and above their existing deposit base. It may also help understand why banks and finance companies have similar leverage ratios, even though the latter are not deposit takers and hence not subject to the same regulatory capital requirements as banks.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: IMFS Working Paper Series ; No. 31

Classification and Topics

• Classification: Wirtschaft ; Banks; Depository Institutions; Micro Finance Institutions; Mortgages ; Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Inderst, Roman ; Müller, Holger
• Event: Veröffentlichung
• (who): Goethe University Frankfurt, Institute for Monetary and Financial Stability (IMFS)
• (where): Frankfurt a. M.
• (when): 2009

Further information

• Handle: http://hdl.handle.net/10419/97748
• URN: urn:nbn:de:hebis:30-72919
• Last update: 10.03.2025, 11:43 AM CET