Financing as a Supply Chain: The Capital Structure of Banks and Borrowers

William Gornall and Ilya Strebulaev ()

No 19633, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a model of the joint capital structure decisions of banks and their borrowers. Strikingly high bank leverage emerges naturally from the interplay between two sets of forces. First, seniority and diversification reduce bank asset volatility by an order of magnitude relative to that of their borrowers. Second, previously unstudied supply chain effects mean that highly levered financial intermediaries are the most efficient. Low asset volatility enables banks to safely take on high leverage; supply chain effects compel them to do so. Firms with low leverage also arise naturally as borrowers internalize the systematic risk costs they impose on their lenders. Because risk assessment techniques from the Basel II framework underlie our structural model, we can quantify the impact capital regulation and other government interventions have on bank leverage, firm leverage, and fragility. Deposit insurance and the expectation of government bailouts lead not only to risk taking by banks, but increased risk taking by firms. Capital regulation lowers bank leverage but can lead to compensating increases in the leverage of firms, as well as a small increase in borrowing costs.

JEL-codes: G01 G18 G2 G21 G28 G32 G38 (search for similar items in EconPapers)
Date: 2013-11
New Economics Papers: this item is included in nep-ban
Note: AP CF
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Citations: View citations in EconPapers (10)

Published as Will Gornall & Ilya A. Strebulaev, 2018. "Financing as a Supply Chain: The Capital Structure of Banks and Borrowers," Journal of Financial Economics, .

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