Comments on “Bank Liability Structure”
by M Suresh Sundaresan, Columbia University, and
Zhenyu Wang, Indiana University
By Stijn Claessens
Head of Financial Stability Policy, Monetary and Economic Department
Bank for International Settlements
Disclaimer: The opinions expressed are those of the author and do not necessarily
reflect views of the Bank for International Settlements.
Question and Answer of Paper
 Q: What is the optimal bank liability structure?
 With liquidity services on deposits, endogenous debt
default, and in continuous time
 And with a deposit insurance, regulatory closure rule
 A: Bank’s choice and closure rule overlap
 Maximizing bank‘s valuation overlaps with DI agency’s
interests, as DIA provides value for bank owners
 Suggest less conflicts, but still adverse effects
 Bank offsets: higher leverage, preference for debt
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1. Relevance of and praise for paper
 Surely a worthwhile topic, also for policy
 Know too little on what drives banks’ choices in the presence
of deposit insurance, even less so in infinite model
 Many focused on this: banks, regulations, supervisors...
 Praise and agree with main findings
 Careful analysis, extending typical two period model
 Results include and extend other theories, with capital
adequacy requirements, taxes, liquidity benefits, etc
 Calibrations show ability for close match; simulations useful
 And hard to disagree after having been presented at 14
seminars and with 16 other commenters!
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2. Main mechanism

DI has benefits that arise via two channels:

DI makes it easier to attract deposits, as bank more secure,
which increases franchise value – since deposits earn fee income
and for depositors have liquidity services – and makes bank raise
leverage

DIA has lower bankruptcy costs (higher recovery value) than
depositor could on their own  Novation lowers bankruptcy costs

Bank internalises and then its choices and deposit insurance align

To maximise franchise value, bank takes deposits and debt, but
avoids debt default before regulatory closure as then benefits lost

No conflict of interests and no insurance “subsidy,” but still higher
leverage, through more deposits, compared to no insurance bank
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3a. Main comment: internalisation

Bank internalises the benefit of DI and DIA’s bankruptcy role
 Bank prefers deposits. And avoids debt default as then DIA not
involved in bankruptcy. Creates a “nice” endogenous boundary,
and gets, even without tax benefits, higher leverage

But how do the modelling choices matter? Two examples:
 Nature of the shocks on assets, now log-normal. Also continuous
time: agents can reoptimise any time, “just in time”
 All common in finance. But could imagine others, eg, jump
processes  DIA cannot reprice/readjust every moment
 No principal agent issues, moral hazard, information asymmetries
 But likely agency and information issues, eg, management
has private benefits; debt holders do not know riskiness; etc
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3b. Main comment: bank assets

Banks assets side ignored, focus is on deviations from M&M liabilities

Risk taking happens through maximising liabilities’ benefits. But
many bank defaults consequences of risky asset choices. Results
are surely not independent of endogenizing bank asset choices

Literature gives large role of guarantees on bank risk taking on assets

Typical moral hazard story, exacerbated by low interest rate

But also complex interaction with liabilities. For example,
Cordella, Dell’Ariccia, Marquez: effect of government guarantees.
If debt is priced at the margin, risk taking incentives increase. If
not, franchise value increases which can induce more prudent
behaviour

Therefore worth considering both sides of balance sheets next
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3c. Main comment: overall system, general
equilibrium

What is DIA’s objective? What should it be?

DIA here acts microprudential, does not try to achieve social
optimal, not even macroprudential, financial stability goals

But social welfare can require adaption of DIA’s goals

Here: what are “optimal” closure rules and capital requirements?

Beyond: general equilibrium impacts of DI, bank regulation and
supervision on: asset prices, non-bank financial intermediation, etc

And systemic crises present real challenges

Bank runs are typically not isolated events (even Northern Rock
was not); then spillovers to other banks via runs, asset prices, etc

Can one design DI rules that internalise (some of these) systemic
effects? eg, are ex-ante or ex-post premiums better?
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Minor comments
 Literature, framing: could be cast broader
 Other recent dynamic models of banks, with also
general equilibrium (Brunnermeier-Sannikov, Begenau,
De Nicole et al, etc)
 Discussion on actual bankruptcy costs not so clear
 Present bankruptcy costs for non-financial corporation,
but these may not reflect the cost to the DIA, which are
the ones modelled
 Could reduce simulations as most follow logically. Instead
think more on the optimal DI and regulatory designs
 Minor. Not sure what a “structural” model is. And the
calibrations likely “match” the real world by design 
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