We develop a theory of optimal bank leverage in which the benefit of debt in inducing
loan monitoring is balanced against the benefit of equity in attenuating risk-shifting.
However, faced with socially-costly correlated bank failures, regulators bail out creditors.
Anticipation of this generates multiple equilibria, including one with systemic risk in which
banks use excessive leverage to fund correlated, inefficiently risky loans. Limiting leverage and resolving both moral hazards?insufficient loan monitoring and asset substitution?requires a novel two-tiered capital requirement, including a ?special capital account? that is unavailable to creditors upon failure.
The large companies that currently file for Chapter 11 look very different than the typical Chapter 11 cases of the past. The liability side of debtors’...
In recent years, there has been a significant increase in the issuance of sustainability-linked loans (SLLs), where loan contract terms depend on the...
The recent bailout of Credit Suisse is noteworthy for many reasons. One of them is that, while AT1 bondholders were wiped out, shareholders were not. This...