Bank Opacity and Deposit Rates

Banks face a dual mandate of raising cheap deposits while avoiding liquidity risk. We propose a novel mechanism whereby banks use portfolio opacity to meet this objective. Specifically, banks choose opaque portfolios to secure cheap long-term funding while trading off insolvency and illiquidity. We show that while opacity lowers deposit rates, it also leaves depositors with only noisy information about the bank’s solvency, making them cautious about keeping their funds in the bank—particularly when interest rates are high. We show that opacity raises bank profits, sometimes at the cost of exposure to high probability of illiquidity. In particular, in high-rate environments, banks adopt excessive opacity to further reduce deposit rates—at the cost of more frequent early failures.