Dynamic Banking and the Value of Deposits

Patrick Bolton, Ye Li, Neng Wang and Jinqiang Yang
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Patrick Bolton: Columbia U and Imperial College London
Ye Li: Ohio State U
Jinqiang Yang: Shanghai U of Finance and Economics

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: We propose a dynamic theory of banking where the role of deposits is akin to that of productive capital in the classical Q-theory of investment for non-financial firms. As a key source of leverage, deposits create value for well-capitalized banks. However, unlike productive capital of nonfinancial firms that typically has a positive marginal q, the deposit q can turn negative for undercapitalized banks. Demand deposit accounts commit banks to allow holders to withdraw or deposit funds at will, so banks cannot perfectly control leverage. Therefore, for banks with insufficient capital to buffer risk, deposit inflow destroys value through the uncertainty it brings in future leverage. This intertemporal channel complements the focus of static models on value destruction of deposit outflow and bank run. Our model predictions on bank valuation and dynamic asset-liability management are broadly consistent with the evidence. Moreover, our model lends itself to a re-evaluation of the costs and benefits of leverage regulation, offers alternative perspectives on banking in a low interest rate environment, and reveals new aspects of deposit market power that has unique implications on bank franchise value.

JEL-codes: E4 E5 G21 G3 (search for similar items in EconPapers)
Date: 2020-12
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mac
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Citations: View citations in EconPapers (14)

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Related works:
Working Paper: Dynamic Banking and the Value of Deposits (2020)
Working Paper: Dynamic Banking and the Value of Deposits (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2020-13

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