Narrow banking

Abstract: Loans are illiquid when a lender needs relationship‐specific skills to collect them. Consequently, if the relationship lender needs funds before the loan matures, she may demand to liquidate early, or require a return premium, when she lends directly. Borrowers also risk losing funding. The costs of illiquidity are avoided if the relationship lender is a bank with a fragile capital structure, subject to runs. Fragility commits banks to creating liquidity, enabling depositors to withdraw when needed, while buffering borrowers from depositors' liquidity needs. Stabilization policies, such as capital requirements, narrow banking, and suspension of convertibility, may reduce liquidity creation.

Abstract: This paper addresses a basic, yet unresolved, question: Do claims on private assets provide sufficient liquidity for an efficient functioning of the productive sector? Or does the state have a role in creating liquidity and regulating it either through adjustments in the stock of government securities or by other means? In our model, firms can meet future liquidity needs in three ways: by issuing new claims, by obtaining a credit line from a financial intermediary, and by holding claims on other firms. When there is no aggregateuncertainty, we show that these instruments are sufficient for implementing the socially optimal (second‐best) contract between investors and firms. However, the implementation may require an intermediary to coordinate the use of scarce liquidity, in which case contracts with the intermediary impose both a maximum leverage ratio and a liquidity constraint on firms. When there is only aggregate uncertainty, the private sector cannot satisfy its own liquidity needs. The government ca...

Abstract: What ties together the traditional commercial banking activities of deposittaking and lending? We argue that since banks often lend via commitments, their lending and deposit-taking may be two manifestations of one primitive function: the provision of liquidity on demand. There will be synergies between the two activities to the extent that both require banks to hold large balances of liquid assets: If deposit withdrawals and commitment takedowns are imperfectly correlated, the two activities can share the costs of the liquid-asset stockpile. We develop this idea with a simple model, and use a variety of data to test the model empirically. WHAT ARE THE DEF INING CHARACTERISTICS of a bank? Both the legal definition in the United States and the standard answer from economists is that commercial banks are institutions that engage in two distinct types of activities, one on each side of the balance sheet—deposit-taking and lending. More precisely, deposit-taking involves issuing claims that are riskless and demandable, that is, claims that can be redeemed for a fixed value at any time. Lending involves acquiring costly information about opaque borrowers, and extending credit based on this information. A great deal of theoretical and empirical analysis has been devoted to understanding the circumstances under which each of these two activities might require the services of an intermediary, as opposed to being implemented in arm’s-length securities markets. While much has been learned from this work, with few exceptions it has not addressed a fundamental question: why is it important that one institution carry out both functions

Abstract: Demandable-debt finance by banks warrants explanation because it entails costs of bank suspension, liquidation, and idle reserve holdings. An explanation is developed in which demandable debt provides incentive-compatible intermediation where the banker has comparative advantage in allocating investment funds but may act against the interests of uninformed depositors. Demandable debt attracts funds by giving depositors an option to force liquidation. Its usefulness in transacting follows from information-sharing between monitors and nonmonitors. Copyright 1991 by American Economic Association.