Bank Liability Structure Research Articles

Optimal design of deferred compensation for bank executives under agency conflicts

AbstractWe analyze the optimal design of deferred compensation for bank executives under agency conflicts in a continuous time model with a bank liability structure. Our model demonstrates that a well‐designed deferred compensation contract can effectively mitigate bank executives' asset substitution problem and significantly enhance the total value of the bank, which aligns with existing empirical studies. Moreover, we find that the motivation for bank executives to shift risk under deferred compensation is diminished when supervision is more stringent, the bank has greater market power, or the write‐down ratio of debt is lower.

Bank liability structure and corporate employment: Evidence from a quasi-natural experiment in China

We examine how bank liability structure affects firms' hiring decisions. To identify causality, we utilize the 2014 interbank borrowing reform that has different impacts on national and regional banks as an exogenous shock. Particularly, we construct the exposure of firms to this reform and then run a difference-in-differences regression. The results show that an increase in banks' deposit funds promotes corporate employment, and the number of total employees on average increases by 4.4%. Further mechanism tests find that banks provide more loans and firms obtain more access to bank credit, confirming the credit constraints channel. Moreover, the corporate employment promotion effect is stronger when financial constraints, information disclosure quality and labor intensity are higher. In addition, firms' employee composition and average wage paid to workers do not change, while their productivity and production scale increase. Overall, our evidence highlights the active role of regulating banks' interbank borrowing in stabilizing social employment.

Strategic Bank Liability Structure Under Capital Requirements

Banks strategically choose and dynamically restructure deposits and nondeposit debt in response to the minimum requirements on total capital and tangible equity. We derive the optimal strategic liability structure and show that it minimizes the protection for deposits conditional on capital requirements. Although, given any liability structure, regulators can set capital requirements high enough to remove the incentive for risk substitution, the strategic response to the capital requirements always preserves this incentive. Banks reduce leverage but increase the proportion of nondeposit debt if regulations raise the capital requirements.This paper was accepted by Lukas Schmid, finance.Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4570 .

Tax effects on bank liability structure

Using supervisory data, we test the tax effects on the liability structure (the composition of deposits and other forms of debt) of the credit cooperative banks (BCC) by exploiting exogenous variations in the rates of tax on productive activities (IRAP) across Italian regions and over time. The testable predictions are derived from a model of bank liability structure that incorporates regulatory closure, endogenous default, and deposit insurance. We show that banks endogenously respond to tax cuts mainly by reducing non-deposit debt ratios, instead of deposit ratios, when lowering leverage. The overall liability structure adjustment substantially reduces non-equity funding costs.

The Design of Stratified Contingent Bank Liability Structure to Release Risk Incentive Effects

This paper proposes a new type of bank liability structure with stratified contingent capital based on the suggestions of Basel III and TLAC Term Sheet. It try to solve the problem that the total loss absorbing capacity of global systemically important banks is insufficient and the single contingent capital-CoCos will bring extra risk to the bank in recent years. Compared with single contingent capital, the bail-in mechanism of stratified contingent capital is more complex and its risk effects will be more uncertain. Therefore, this paper studies how to design the parameters setting of stratified contingent liability structure to release the incentive effect of original shareholders’ risk taking. Firstly, it analyzed the basic setting of bank capital structure and bail-in mechanism. And then, it calculated the value of CoCos, TLAC bonds, and original shareholders’ equity by replicating payoffs using sets of exotic options. Finally, it calculated the elasticity of the original shareholders’ equity value to the volatility of asset value. The elasticity is used to analyze the incentive effect of original shareholders’ risk taking. The numerical analysis shows that risk incentive effect is more sensitive to the parameters setting of CoCos. In any case, conversion rate has a more important impact than the trigger threshold. In particular, the effect of risk taking can be eliminated by setting the parameters properly.

How monetary policy changes bank liability structure and funding cost

Abstract US banks obtain most of their funding from a combination of low-interest deposits and high-interest deposits. Using local demographic variations as instruments for banks’ liability composition, I show that when monetary policy tightens, banks with a larger proportion of low-interest deposits on their balance sheet experience larger increases in their high-interest deposit rate and lend less. This happens because tight monetary policy reduces the supply of low-interest deposits to banks, and banks react by issuing more high-interest deposits. As it is increasingly expensive, that substitution is not complete, and leads to a reduction in lending.

An Empirical Investigation into the Effect of Explicit Deposit Insurance and Design on the Liability Structure of Banks

Abstract This paper provides an insight into the behaviour of the liability side of bank balance sheet in response to explicit deposit insurance. It is an empirical investigation into the choice of a rational bank maximizing its bank value in terms of deposit and non-deposit liabilities after the implementation of explicit deposit insurance. The paper tests how banks' liabilities are affected because of the safety net and its design. Banks lower their leverage ratio as a response to the explicit deposit insurance. The paper finds evidence of depositor shifting funds between the types of deposits in the bank as a result of the explicit deposit insurance. It provides evidence of the importance of setting the right coverage in order to prevent the adverse effects that deposit insurance induces. It studies how the safety net design features affect the bank liability structure. The study finds that besides the explicit deposit insurance, the bank liability structure is affected by factors like tax expense, bank size, overheads, and dividend payout.

The Effects of Tax on Bank Liability Structure

This paper examines the effects of taxation on the liability structure of banks. We derive testable predictions from a dynamic model of optimal bank liability structure that incorporates bank runs, regulatory closure and endogenous default. Using the supervisory data provided by the Bank of Italy, we empirically test these predictions by exploiting exogenous variations of the Italian tax rates on productive activities (IRAP) across regions and over time (especially since the global financial crisis). We show that banks endogenously respond to a reduction in tax rates by reducing nondeposit liabilities more than deposits in addition to lowering leverage. The response on the asset side depends on the financial strength of the bank: well-capitalized banks respond to a reduction in tax rates by increasing their assets, but poorly-capitalized banks respond by cleaning up their balance sheet.

The shadow costs of repos and bank liability structure

Making use of a structural model that allows for optimal liquidity management, we study the role that repos play in a bank׳s financing structure. In our model the bank׳s assets consist of illiquid loans and liquid reserves and are financed by a combination of repos, long-term debt, deposits and equity. Repos are a cheap source of funding, but they are subject to an exogenous rollover risk. We show that the use of repos inflicts two types of indirect (“shadow”) costs on the bank׳s shareholders: first, it induces the bank to maintain higher liquid reserves in order to alleviate the additional default risk; second, it adds to the cost of long-term debt financing. These shadow costs limit the bank׳s appetite for cheap but unstable repo funding. This effect is, however, weakened under poor returns on risky assets, access to deposit funding and the depositor preference rule. We also analyze the impact of a liquidity coverage ratio, payout restrictions and a leverage ratio on the bank׳s financing choices and show that all these tools are able to curb the bank׳s reliance on repos.

How Monetary Policy Changes Bank Liability Structure and Funding Cost

U.S. banks obtain most of their funding from a combination of zero-interest deposits and interest-bearing deposits. Using local demographic variations as instruments for banks' liability composition, I show that when monetary policy tightens, banks with a larger proportion of zero-interest deposits on their balance sheet experience larger increases in their interest-bearing deposit rate. This happens because tight monetary policy reduces the quantity of zero-interest deposits available to banks. Banks react issuing more interest-bearing deposits, but pay an interest rate that increases with the quantity being borrowed. This new evidence supports the existence of the bank lending channel of monetary policy.

Bankruptcy Remoteness and Incentive‐compatible Securitization

Securitization involves both the risk allocation and claims' transferability/liquidity. A key ingredient of liquidity/claim‐transferability is bankruptcy remoteness of the securitized assets. We analyze the implications of the bankruptcy‐remoteness created by securitization on risk allocation and bank monitoring incentives, in relation to the bank's liability structure; and the regulatory/policy issues it gives rise to. We demonstrate that (1) the need for regulation arises when securitization (and bankruptcy remoteness) coexists with deposit‐taking; and (2) regulation that imposes the same capital requirements on a bank irrespective of whether loans are securitized or not will have welfare implications. We also explain the need for narrow‐securitized banking.

How Monetary Policy Changes Bank Liability Structure and Funding Cost

U.S. banks obtain most of their funding from a combination of zero-interest deposits and interest-bearing deposits. Using local demographic variations as instruments for banks’ liability composition, I show that when monetary policy tightens, banks with a larger proportion of zero-interest deposits on their balance sheet experience larger increases in their interest-bearing deposit rate. This happens because tight monetary policy reduces the quantity of zero-interest deposits available to banks. Banks react issuing more interest-bearing deposits, but pay an interest rate that increases with the quantity being borrowed. This new evidence supports the existence of the bank lending channel of monetary policy.

Short Term Debt and Bank Liability Structure

Making use of a structural model that allows for optimal liquidity management, we study the role that repos play in a bank’s financing structure. In our model the bank’s assets consist of illiquid loans and liquid reserves and are financed by a combination of repos, long–term debt, deposits and equity. Repos are a cheap source of funding, but they are subject to an exogenous rollover risk. We show that the use of repos inflicts two types of indirect (“shadow”) costs on the bank’s shareholders: first, it induces the bank to maintain higher liquid reserves in order to alleviate the additional default risk; second, it adds to the cost of long–term debt financing. These shadow costs limit the bank’s appetite for cheap but unstable repo funding. This effect is, however, weakened under poor returns on risky assets, access to deposit funding and the depositor preference rule. We also analyze the impact of a liquidity coverage ratio, payout restrictions and a leverage ratio on the bank’s financing choices and show that all these tools are able to curb the bank’s reliance on repos.

Bank Liability Structure

This paper develops a dynamic continuous-time model of optimal bank liability structure that incorporates the liquidity services on deposits, deposit insurance, regulatory closure, and endogenous default in banks' financing decisions. Nesting the classic model for non-financial firms as a special case, the model clearly explains why banks use higher leverage than non-financial firms. The model shows that a value-maximizing bank balances between deposits and debt so that its endogenous default coincides with the regulatory closure in order to maximize the tax benefits of debt and minimize the protection for deposits. Banks' optimal responses to regulatory changes often counteract regulators' objectives.

Bank Liability Structure, FDIC Loss, and Time to Failure: A Quantile Regression Approach

Deposit insurers are particularly concerned about high-cost failures. When the factors driving such failures differ systematically from the determinants of low- and moderate-cost failures, a new estimation technique is required. Using a sample of more than 1,000 bank failures in the U.S. between 1984 and 2003, I present a quantile regression approach that illustrates the sensitivity of the dollar value of losses in different quantiles to my explanatory variables. These findings suggest that reliance on standard econometric techniques results in misleading inferences, and that losses are not homogeneously driven by the same factors across the quantiles. I also find that liability composition affects time to failure.

Bank Liability Structure, FDIC Loss, and Time to Failure: A Quantile Regression Approach

Previous studies that aim to determine factors impacting the deposit insurer's loss arising from bank failures use standard econometric techniques that assume the losses are homogeneously driven by the same set of explanatory variables: However, deposit insurers are particularly concerned about high-cost failures. If the factors driving high-cost failures differ systematically from the determinants of low and moderate-cost failures, an alternative estimation technique is required. Using a sample of more than 1,000 bank failures in the US between 1984 and 1996, we present a quantile regression approach that illustrates the sensitivity of the dollar value of losses in different quantiles to our explanatory variables. The findings suggest that reliance on standard econometric techniques gives rise to misleading inferences and that losses are not homogeneously driven by the same factors across the quantiles. We also find that liability structure affects time to failure and that both insured and uninsured depositors are a source of market discipline.

Should Bank Liability Structure Influence Deposit Insurance Pricing?

In this paper, I discuss the influence of the banking industry's liability structure on the FDIC's risk exposure, the relationship between this exposure and the assessment base, and various ways that the FDIC could incorporate the effects of bank liability structure into its price for deposit insurance. For most of the industry, I find that the FDIC's risk exposure increases when banks move from domestic deposits to other funding sources because decreases in assessment income associated with a smaller assessment base are not offset by reductions in the FDIC's exposure to loss. However, this may not be the case for banks that rely heavily on unsecured credits due to the benefits of market discipline. I outline three ways to incorporate bank liability structure into the FDIC's pricing policy for deposit insurance: 1) change the assessment base; 2) adjust the pricing matrix; and 3) price directly for risk. I conclude that no such changes should be made in isolation. In particular, issues related to bank size must also be addressed because any change associated with liability structure would effectively shift the assessment burden towards larger banks. The FDIC's historical loss experience indicates that, in terms of cost per dollar of expected FDIC losses, large banks already pay considerably more for deposit insurance than small banks. Even though certain characteristics of very large banks may justify higher prices, the size of the current price differential across bank size, combined with the correlation between asset size and liability structure, means that a simple adjustment to the FDIC's pricing policy for bank liability structure would be unwise. Instead, a holistic approach is warranted, considering numerous factors simultaneously.

Entry in Commercial Banking

ENTRY occupies a prominent place in economic theory. Yet just as prominent is the almost complete lack of empirical investigation of the subject.' This article attempts to identify empirically the determinants of entry in one industry-commercial banking in the United States-in the hope that it may throw light on the determinants of entry in general. The choice of commercial banking for this study does not rest entirely on the ready availability of the relevant data for this industry. It also affords the chance to investigate another topic lightly treated in the empirical literature-the effects of economic regulation on economic performance. Entry into banking is today closely regulated; the formation of a new bank requires a license, denial of which is non-reviewable, from an appropriate government agency. This article will attempt to measure the extent to which actual entry in banking has been affected by the legal restrictions upon it. The historical development of the legal restrictions on entry in banking can be summarized briefly. The century prior to 1935 may fairly be described as an era of "free banking," though the history books apply the term only to the part of this period up to the National Bank Act of 1863. Such legal restrictions as were placed on the formation of new banks by both Congress and state legislatures in 1863 and thereafter were largely ineffective. The reason for this was that the state and Federal chartering authorities operated independently of one another-neither had any check on the other within a given state. This legal framework encouraged competition between state and