EconPapers    
Economics at your fingertips  
 

Why High Leverage Is Optimal for Banks

Harry DeAngelo and René Stulz
Additional contact information
Harry DeAngelo: Marshall School of Business, University of Southern California and OH State University

Working Papers from University of Pennsylvania, Wharton School, Weiss Center

Abstract: Liquidity production is a central role of banks. When there is a market premium for the production of (socially valuable) liquid financial claims and no other departures from the Modigliani and Miller (1958, MM) assumptions, we show that high leverage is optimal for banks. In this model, high leverage is not the result of distortions from agency problems, deposit insurance, or tax motives to borrow. The model can explain (i) why bank leverage increased over the last 150 years or so without invoking any of these distortions, (ii) why high bank leverage per se does not necessarily cause systemic risk, and (iii) why limits on the leverage of regulated banks impede their ability to compete with unregulated shadow banks. MM's leverage irrelevance theorem is inapplicable to banks: Because debt-equity neutrality assigns zero weight to the social value of liquidity, it is an inappropriately equity-biased baseline for assessing whether the high leverage ratios of real-world banks are excessive or socially destructive.

Date: 2013-05
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (37) Track citations by RSS feed

Downloads: (external link)
http://fic.wharton.upenn.edu/fic/papers/13/13-20.pdf
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://fic.wharton.upenn.edu/fic/papers/13/13-20.pdf [301 Moved Permanently]--> https://wifpr.wharton.upenn.edu/fic/papers/13/13-20.pdf)

Related works:
Working Paper: Why High Leverage Is Optimal for Banks (2013) Downloads
Working Paper: Why High Leverage is Optimal for Banks (2013) Downloads
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ecl:upafin:13-20

Access Statistics for this paper

More papers in Working Papers from University of Pennsylvania, Wharton School, Weiss Center Contact information at EDIRC.
Bibliographic data for series maintained by ().

 
Page updated 2022-09-25
Handle: RePEc:ecl:upafin:13-20