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A general equilibrium theory of banks' capital structure

Gale, Douglas and Gottardi, Piero (2020) 'A general equilibrium theory of banks' capital structure.' Journal of Economic Theory, 186. ISSN 0022-0531

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Abstract

We develop a general equilibrium theory of the capital structures of banks and firms. The liquidity services of bank deposits make deposits a “cheaper” source of funding than equity. In equilibrium, banks pass on part of this funding advantage in the form of lower interest rates to firms that borrow from them. Firms and banks choose their capital structures to balance the benefits of debt financing against the risk of costly default. An increase in the equity of a firm makes its debt less risky and that in turn reduces the risk of the banks who lend to the firm. Hence there is some substitutability between firm and bank equity. We find that firms have a comparative advantage in providing a buffer against systemic shocks, whereas banks have a comparative advantage in providing a buffer against idiosyncratic shocks.

Item Type: Article
Uncontrolled Keywords: Capital structure, Bank financing, Liquidity, Bankruptcy costs, Banks firms linkages
Divisions: Faculty of Social Sciences > Economics, Department of
Depositing User: Elements
Date Deposited: 31 Jan 2020 13:01
Last Modified: 31 Jan 2020 13:15
URI: http://repository.essex.ac.uk/id/eprint/26608

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