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Asset encumbrance, bank funding and fragility

Ahnert, Toni, Anand, Kartik, Gai, Prasanna and Chapman, James (2018) Asset encumbrance, bank funding and fragility. Systemic Risk Centre Discussion Papers (83). Systemic Risk Centre, The London School of Economics and Political Science, London, UK.

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We model asset encumbrance by banks subject to rollover risk and study the consequences for fragility, funding costs, and prudential regulation. A bank's privately optimal encumbrance choice balances the benefit of expanding profitable yet illiquid investment, funded by cheap long-term senior secured debt, against the cost of greater fragility from runs on unsecured debt. We derive testable implications about encumbrance ratios. The introduction of deposit insurance or wholesale funding guarantees induces excessive encumbrance and fragility. Ex-ante limits on asset encumbrance or ex-post Pigovian taxes eliminate such risk-shifting incentives. Our results shed light on prudential policies currently pursued in several jurisdictions.

Item Type: Monograph (Discussion Paper)
Official URL:
Additional Information: © 2018 The Authors
Divisions: Systemic Risk Centre
Subjects: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HG Finance
JEL classification: G - Financial Economics > G0 - General > G00 - General
G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation
Date Deposited: 31 May 2023 10:54
Last Modified: 16 May 2024 12:27

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