Stepwise Maturity Transformation - Intermediation Chains as a Way to Reconcile Different Purposes of Debt Financing

Abstract

This paper provides a theory of stepwise maturity transformations in intermediation chains, which have become a common form of financial intermediation (an example is banks with long-term assets that sell commercial paper with month-long duration to money market funds with daily demandable shares). This theory reconciles the idea of debt as disciplining device with the idea of debt as 'money-like' claim. In a first step, the paper shows that the optimal disciplining of managers requires a higher debt level but a longer debt duration than the optimal provision of money-like claims. In a second step, the paper explains how this conflict between the two purposes of debt financing can be resolved by a partial separation: a bank issues debt with 'medium' duration that is optimal for disciplining managers, while a fund holds this medium-term debt and issues short-term debt that is optimal for providing money-like claims.