B8 Bank capital structure

Question 1

What are bank, what do they do?

Answer 1

(1) Maturity transformation: Banks lend long-term and borrow short-term
(2) Monitoring investments: Banks are well placed to make and control long-term investments
(3) Creators of “money”: Banks issue “claims” that can be used for payment

Question 2

Does MM apply to banks?

Answer 2

MM: Capital structure irrelevant because investors can achieve homemade leverage
Special for banks: Bank deposits are insured, (some) banks get „bailed-out”
Typical statement: Because equity is costly, bank managers often want to hold less bank capital than required by regulator.

Question 3

Why regulate banks?

Answer 3

Lack of market discipline:
deposit insurance
free-riding among depositors
inability of outsiders to monitor bank
This is a problem, when private cost < social cost of bank failure/distress:
negative externalities
Fire sales / market break-down
too big to fail / subsidized debt
some bank behavior seems far from being “constrained efficient”

Question 4

Summary Bank capital structure

Answer 4

(1) Banks are still not perfectly understood
(2) The case for regulation seems clear
(3) But how and to what extent is unclear