NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

A Theory of Bank Capital

Douglas W. Diamond, Raghuram G. Rajan

NBER Working Paper No. 7431
Issued in December 1999
NBER Program(s):   CF   ME

Banks can create liquidity because their deposits are fragile and prone to runs. Increased uncertainty can make deposits excessively fragile in which case there is a role for outside bank capital. Greater bank capital reduces liquidity creation by the bank but enables the bank to survive more often and avoid distress. A more subtle effect is that banks with different amounts of capital extract different amounts of repayment from borrowers. The optimal bank capital structure trades off the effects of bank capital on liquidity creation, the expected costs of bank distress, and the ease of forcing borrower repayment. The model can account for phenomena such as the decline in average bank capital in the United States over the last two centuries. It points to overlooked side-effects of policies such as regulatory capital requirements and deposit insurance.

download in pdf format
   (155 K)

email paper

This paper is available as PDF (155 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w7431

Published: Diamond, Douglas W. and Raghuram G. Rajan. "A Theory Of Bank Capital," Journal of Finance, 2000, v55(6,Dec), 2431-2465. citation courtesy of

Users who downloaded this paper also downloaded these:
Beck, Demirguc-Kunt, and Levine w9921 Bank Concentration and Crises
Diamond and Rajan w16994 Illiquid Banks, Financial Stability, and Interest Rate Policy
Diamond and Rajan w14739 The Credit Crisis: Conjectures about Causes and Remedies
Diamond and Rajan w10070 Money in a Theory of Banking
Diamond and Rajan w7764 Banks, Short Term Debt and Financial Crises: Theory, Policy Implications and Applications
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us