We explain the emergence of a variety of intermediaries in a model based only on differences in their funding costs. Banks have a low cost of capital due to, say, safety nets or money-like liabilities. We show, however, that this can be a disadvantage, because it exacerbates soft-budget-constraint problems, making it costly to finance innovative projects. Non-banks emerge to finance them. Their high cost of capital is an advantage, because it works as a commitment device to withhold capital, solving soft-budget-constraint problems. Still, non-banks never take over the entire market, but coexist with banks in equilibrium.
We gratefully acknowledge helpful comments from Philp Bond (editor), two anonymous referees, Mike Burkart, Francesca Cornelli, Giovanni Dell’Ariccia, Philip Dybvig, Daniel Ferreira, Radha Gopalan, Vincent Glode, Denis Gromb, Ohad Kadan, Nataliya Klimenko, Mina Lee, Adrien Matray, Asaf Manela, Alan Morrison, Balazs Szentes, Basil Williams, Andy Winton, Vijay Yerramilli, Kostas Zachariadis, Jean-Pierre Zigrand and seminar participants at the 2015 EFA Summer Meetings, the 2015 FIRS Conference, the 2017 Five Star Conference, the London School of Economics, the 2018 SFS Cavalcade, and Washington University in St. Louis. Xiabo Yu provided outstanding research assistance. We alone are responsible for any remaining errors. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.