Deposit Collateral and the Role of Banks

Posted: 25 Dec 2004

See all articles by Hirofumi Uchida

Hirofumi Uchida

Kobe University - Graduate School of Business Administration

Abstract

This paper explains the rationale behind deposit collateral that has not been discussed in the literature on financial contracting. In our model extending Hart and Moore (1998) to account for liquidity shocks, deposit collateral has potentially two important effects: the enhancement of pledgeability and the provision of liquidity. We show that only if liquidity shocks are stochastic, both effects are significant and overall efficiency is improved. This improvement is the raison d'etre of deposit collateral. The result also establishes a unique role for banks, since deposit collateral can only be taken by these financial institutions. Furthermore, it is shown that the collateral can be implemented in the form of compensating balance requirements with or without commitment loans and is attached with less restrictive efficiency conditions than alternative lending arrangements.

Keywords: Deposit collateral, liquidity, pledgeability, commitment loans, compensating balance

JEL Classification: G21, G33

Suggested Citation

Uchida, Hirofumi, Deposit Collateral and the Role of Banks. European Finance Review, Vol. 7, pp. 409-435, 2003, Available at SSRN: https://ssrn.com/abstract=632902

Hirofumi Uchida (Contact Author)

Kobe University - Graduate School of Business Administration ( email )

2-1, Rokkodai-cho, Nada-ku
Kobe, 657-8501
Japan
81-78-803-6949 (Phone)

HOME PAGE: http://www.b.kobe-u.ac.jp/~uchida

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