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Keywords:

  • deposit financing;
  • commitment device;
  • bank capital structure;
  • debt structure;
  • contingent claims valuation
  • G21;
  • G32

Abstract

We consider a regulated bank with access to bond and insured deposit financing. Bank manager-owners have specific abilities, which allows them to extract rents. We show that deposit finance acts as a commitment device that has the potential to raise the overall debt capacity of the bank and increases pledgeable assets. Our focus is on the optimal mix of bond and deposit financing. We find that in the optimum, the bank chooses a debt structure so as to align internal incentives with external constraints. The model predicts that banks with more risky assets or with more specialised human capital use deposit financing to a lesser extent.