TY  - JOUR
AU  - Diamond,Douglas W.
AU  - Rajan,Raghuram G.
TI  - A Theory of Bank Capital
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7431
PY  - 1999
Y2  - December 1999
UR  - http://www.nber.org/papers/w7431
L1  - http://www.nber.org/papers/w7431.pdf
N1  - Author contact info:
Douglas W. Diamond
Booth School of Business
University of Chicago
5807 S Woodlawn Avenue
Chicago, IL 60637
Tel: 773/702-7283
E-Mail: douglas.diamond@chicagobooth.edu

Raghuram Rajan
Booth School of Business
University of Chicago
5807 South Woodlawn Avenue
Chicago, IL 60637
Tel: 773/702-4437
Fax: 773/702-0458
E-Mail: raghuram.rajan@ChicagoBooth.edu
AB  - 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.
ER  -