TY  - JOUR
AU  - Lucas,Deborah
AU  - McDonald,Robert L.
TI  - Bank Portfolio Choice with Private Information About Loan Quality:  Theory and Implications for Regulation
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 2421
PY  - 1989
Y2  - June 1989
UR  - http://www.nber.org/papers/w2421
L1  - http://www.nber.org/papers/w2421.pdf
N1  - Author contact info:
Deborah J. Lucas
MIT Sloan School of Management
100 Main Street, E62-640
Cambridge, MA 02142
Tel: 617/715-4816
E-Mail: dlucas@mit.edu

Robert L. McDonald
Department of Finance  Jacobs Center
Northwestern University
2001 Sheridan Rd.
Evanston, IL  60208-2006
Tel: 847-491-8344
Fax: 847-491-5719
E-Mail: r-mcdonald@northwestern.edu
AB  - This paper models bank asset choice when shareholders know more about loan quality than do outsiders. Because of this informational asymmetry, the price of loans in the secondary market is the price for poor quality loans. Banks desire to hold marketable securities in order to avoid liquidating good quality loans at the "lemons" price, but also have a countervailing desire to hold risky loans in order to maximize the value of deposit insurance. In this context, portfolio composition and bank safety is examined as a function of the market distribution of loan quality, and the distribution of deposits. The model suggests that off-balance sheet commitments have little effect on bankruptcy risk, and induce banks to hold more securities. We also show that an increase in the bank equity requirement will unambiguously increase bank safety in the long run. In the short run, banks are unambiguously riskier on-balance-sheet, although the effect on bank safety is ambiguous.
ER  -