Bank Capital, Liquid Reserves, and Insolvency Risk

Erwan Morellec and Julien Hugonnier

No 10378, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We develop a dynamic model to assess the effects of liquidity and leverage requirements on banks' insolvency risk. The model features endogenous capital structure, liquid asset holdings, payout, and default decisions. In the model, banks face taxation, flotation costs of securities, and default costs. They are financed with equity, insured deposits, and risky debt. Using the model, we show that liquidity requirements have no long-run effects on default risk but may increase it in the short-run; leverage requirements reduce default risk but may significantly reduce bank value; mispriced deposit insurance fuels default risk while depositor preference in default decreases it.

Keywords: Banks; Liquidity buffers; Capital structure; Insolvency risk; Regulation (search for similar items in EconPapers)
JEL-codes: G21 G28 G32 G33 (search for similar items in EconPapers)
Date: 2015-02
New Economics Papers: this item is included in nep-ban, nep-cba and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Bank capital, liquid reserves, and insolvency risk (2017)
Working Paper: Bank Capital, Liquid Reserves, and Insolvency Risk (2014)
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