Asset encumbrance, bank funding and fragility

Toni Ahnert, Kartik Anand, Prasanna Gai and James Chapman

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We model asset encumbrance by banks subject to rollover risk and study the consequences for fragility, funding costs, and prudential regulation. A bank's privately optimal encumbrance choice balances the benefit of expanding profitable yet illiquid investment, funded by cheap long-term senior secured debt, against the cost of greater fragility from runs on unsecured debt. We derive testable implications about encumbrance ratios. The introduction of deposit insurance or wholesale funding guarantees induces excessive encumbrance and fragility. Ex-ante limits on asset encumbrance or ex-post Pigovian taxes eliminate such risk-shifting incentives. Our results shed light on prudential policies currently pursued in several jurisdictions.

Keywords: asset encumbrance; bank runs; wholesale funding; secured debt; unsecured debt; encumbrance limits; encumbrance surcharges (search for similar items in EconPapers)
JEL-codes: G00 G21 G28 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2018-09-14
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Downloads: (external link)
http://eprints.lse.ac.uk/118919/ Open access version. (application/pdf)

Related works:
Journal Article: Asset Encumbrance, Bank Funding, and Fragility (2019)
Working Paper: Asset encumbrance, bank funding and fragility (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:118919

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