Working Paper: NBER ID: w31057
Authors: Urban Jermann; Haotian Xiang
Abstract: The majority of bank liabilities are deposits typically not withdrawn for extended periods. We propose a dynamic model of banks in which depositors forecast banks’ leverage and default decisions, and withdraw optimally by trading off current against future liquidity needs. Endogenous deposit maturity creates a time-varying dilution problem that has major effects on bank dynamics. Interest rate cuts produce delayed increases in bank risk which are stronger in low rate regimes. Deposit insurance can exacerbate the deposit dilution and amplify the increase in bank risk.
Keywords: No keywords provided
JEL Codes: E44; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Interest rate cuts (E43) | initial reduction in bank default risk (G21) |
| Interest rate cuts (E43) | increased default risk and leverage (G32) |
| increased default risk and leverage (G32) | boom-bust dynamic in bank risk (E32) |
| low-interest environments (E43) | delayed increase in bank risk (G21) |
| future liquidity benefits of deposits (G21) | less sensitivity to changes in default risk (G19) |
| deposit withdrawals decline after a rate cut (G21) | lengthening deposit maturity (E43) |
| lengthening deposit maturity (E43) | increasing dilution incentives (G19) |