hero working papers

Deposits and Bank Capital Structure

Number: 477
Year: 2013
Author(s): Franklin Allen, Elena Carletti
In a model with bankruptcy costs and segmented deposit and equity markets, we endogenize the choice of bank and firm capital structure and the cost of equity and deposit finance. Despite risk neutrality, equity capital is more costly than deposits. When banks directly finance risky investments, they hold positive capital and diversify. When they make risky loans to firms, banks trade off the high cost of equity with the diversification benefits from a lower bankruptcy probability. When bankruptcy costs are high, banks use no capital and only lend to one sector. When these are low, banks hold capital and diversify.

Keywords: Deposit finance, bankruptcy costs, bank diversification
JEL codes: G21, G32, G33