Working Paper: NBER ID: w26298
Authors: Jason R. Donaldson; Giorgia Piacentino
Abstract: We develop a model in which, as in practice, bank debt is both a financial security used to raise funds and a kind of money used to facilitate trade. This dual role of bank debt provides a new rationale for why banks do what they do. In the model, banks endogenously perform the essential functions of real-world banks: they transform liquidity, transform maturity, pool assets, and have dispersed depositors. Moreover, they make their debt redeemable on demand. Thus, they are endogenously fragile. We show novel effects of narrow banking, suspension of convertibility, and some other policies.
Keywords: bank debt; money; financial stability; demandable debt
JEL Codes: G01; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banks issue demandable debt (G21) | leverage the price effect of demandability (G19) |
| demandable debt trades at a higher price in secondary markets (G19) | enhances banks' debt capacity (G21) |
| demandable debt (H63) | exposes banks to a new kind of run (money run) (E44) |
| fragility of banks (F65) | consequence of the fragility of money (E41) |
| suspension of convertibility (F33) | can prevent runs (E44) |
| suspension of convertibility (F33) | may restore circulation of bank debt (G21) |
| increasing the redemption value of bank debt (G21) | paradoxically make banks more susceptible to runs (E44) |
| banks' choices regarding demandable debt (G21) | influenced by the price effects of such debt (H63) |
| banks' choices regarding demandable debt (G21) | influenced by the inherent risks associated with liquidity crises (G33) |