Working Paper: CEPR ID: DP10505
Authors: Rafael Matta; Enrico Perotti
Abstract: We study bank funding choices under asset liquidity risk and a realistic bankruptcy process, where illiquid assets are shared among all unpaid creditors. Repo debt is cheap and stable but shifts risk to unsecured debt. In the unique equilibrium, repo has a nonmonotonic effect. Runs are rare when unpledged liquid assets are abundant, rise as more repo funding shifts risk, and ultimately fall as less liquidity is available for early withdrawals. The socially optimal choice minimizes inefficient runs by limiting repo or by subsidizing a high rollover yield on unsecured debt. The private choice uses more repo and a lower rollover reward, trading off runs against cheaper funding
Keywords: bank runs; haircuts; repo; secured credit
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| repo funding (E52) | likelihood of runs (C25) |
| unpledged liquid assets abundant (G33) | likelihood of runs (C25) |
| increased repo funding (E50) | risk shifts (J62) |
| risk shifts (J62) | likelihood of runs (C25) |
| liquidity scarce (G33) | likelihood of runs (C25) |
| socially optimal choice limits repo funding (E44) | inefficient runs (D61) |
| private choices (D10) | repo usage (C59) |
| private choices (D10) | rollover yields (G12) |
| lower rollover yields (E43) | likelihood of runs (C25) |