Dynamic Banking and the Value of Deposit

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Abstract/Contents

Abstract: We propose a dynamic theory of banking where the role of deposits is akin to that of productive capital in the classical Q-theory of investment for non-financial firms. As a key source of leverage, deposits create value for well-capitalized banks. However, unlike capital of nonfinancial firms, deposits can have a negative marginal q for undercapitalized banks. Demand deposit accounts commit banks to allow holders to withdraw or deposit funds at will, so banks cannot perfectly control leverage. When banks have insufficient equity capital to buffer risk, deposit inflows and the associated uncertainty in future leverage can destroy value. Our model predictions on bank valuation and dynamic asset-liability management are broadly consistent with the evidence. Moreover, our model lends itself to a re-evaluation of the costs and benefits of leverage regulation and offers new perspectives on the challenges that banks face in a low interest rate environment.

Type of resource	text
Date created	September 2, 2021

DOI	https://doi.org/10.25740/jf086rp1664
Location	https://purl.stanford.edu/jf086rp1664

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License: This work is licensed under a Creative Commons Attribution 4.0 International license (CC BY).

Preferred citation: Bolton, P., Li, Y., Wang, N., and Yang, J. (2022). Dynamic Banking and the Value of Deposit. Stanford Digital Repository. Available at https://purl.stanford.edu/jf086rp1664

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