Optimal Intermediary Contracts

Nabi Arjmandi, Chao Gu and Joseph Haslag

No 2209, Working Papers from Department of Economics, University of Missouri

Abstract: Financial intermediaries simultaneously engage in two separate relationships: they accept deposits and they make loans. Yet, researchers have focused either on deposit contracts or loan contracts. In this paper, we develop a theory in which deposit contracts and loan contracts are determined in equilibrium. Borrowers have limited commitment and the banks have access to a direct, safe long-term investment. We then study how changes in the borrower’s creditworthiness affects deposit and loan contracts. We study this relationship across different trading protocols. With deteriorating credit conditions, we find that loan rates can decline (declining spreads) and loan quantities can increase. This is the opposite direction used when constructing things like credit indicators. This relationship is not robust to changes in market structures. Lastly, we show how an aggregate fundamental shock can induce bank runs. However, the bank run is less likely in the worst credit-condition category.

Keywords: deposit contracts; loan contracts; credit conditions; financial indicators (search for similar items in EconPapers)
JEL-codes: D53 E44 G21 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2022-11
New Economics Papers: this item is included in nep-ban, nep-cta, nep-fdg and nep-mic
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Persistent link: https://EconPapers.repec.org/RePEc:umc:wpaper:2209

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