What assets should banks be allowed to hold?

Varadarajan Chari and Christopher Phelan

No 12-3, Economic Policy Paper from Federal Reserve Bank of Minneapolis

Abstract: Banks are vulnerable to self-fulfilling panics because their liabilities (such as demand deposits and certificates of deposit) are short term and unconditional, and their assets (such as mortgages and business loans) are long term and illiquid. To prevent wider financial fallout from such panics, governments have strong incentive to bail out bank debtholders. Paradoxically, expectations of such bailouts can lead financial systems to rely excessively?from a societal perspective?on short-term debt to fund long-term assets. Fragile banking systems thus impose external costs, and regulation may therefore be socially desirable. ; In light of this fragility and cost, we examine two of the major theoretical benefits from the reliance of the banking system on short-term debt: (1) maturity transformation and (2) efficient monitoring of bank managers. We argue that while both justifications may be compelling, they point us to financial regulations very different from the ones currently in place. These theoretical justifications suggest that the assets funded by banks should not have close substitutes in publicly traded markets, as is currently the case.

Date: 2012
New Economics Papers: this item is included in nep-ban and nep-cba
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://minneapolisfed.org/~/media/files/pubs/eppa ... _allowed_to_hold.pdf Full text (application/pdf)

Related works:
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:fip:fedmep:12-3

Access Statistics for this paper

More papers in Economic Policy Paper from Federal Reserve Bank of Minneapolis Contact information at EDIRC.
Bibliographic data for series maintained by Jannelle Ruswick ( this e-mail address is bad, please contact ).