By taking deposits and making loans, banks create private money in an economy– the bank deposits. In this paper I study how the banking system should be designed such that banks can most efficiently create these money-like assets that are both liquid and safe. An endogenously created common pool of liquidity is at the core of this private money creation process– loans made by one bank can generate fresh supply of liquidity to the banking sector before they pay off, which helps to ensure the safety of bank deposits under the exposure to liquidity shocks. I show that under a setting of incomplete markets and incomplete contracts, three market failures potentially plague the private creation of safe assets. First, an incentive problem can lead to ex-ante under-production of the liquidity pool, when banking sector is subject to idiosyncratic liquidity risks. Second, a commitment problem can result in ex-post over-use of the liquidity pool, when banking sector is subject to systemic liquidity risks. Interestingly, more competitive banking markets ensure more efficient ex-ante incentive provision and hence alleviate the under-production problem; however, increased competition also introduces an ex-post commitment issue, which exacerbates the over-use problem. Finally, an ex-ante coordination problem potentially arises when banking markets become sufficiently competitive: no private safe assets can be created in the economy without proper liquidity regulations (e.g. uniform reserve requirements) being imposed. The analysis has implications on regulations of banking markets and bank liquidity for enhancing economy’s resilience to negative shocks. .

Two salient features of the banking sector are its heavy reliance on short-term funding and the existence of imperfect competition in banking markets. This paper investigates how competition in bank funding market generates real impact through affecting the determination of short-term liquidity prices for banks. Exploiting the exogenous variation in banking market competition resulting from the US banking deregulation in 80s and early 90s, this paper documents two novel facts about the real outcome implications of banking market competition. First, while banks’ loan making in general tend to be less local than deposit taking, more competitive banking market enlarges this geographic mismatch between banks’ activities on two sides of their balance sheets. Furthermore, this effect is more pronounced for banks financed with higher shares of uninsured deposits and transaction deposits, as well as for loans made to labor-intensive industries. Second, examination of the lending dynamics of banks hit by the 1986 oil price shock reveals a mixed effect of banking market competition on economy’s resilience to unexpected shocks. More competitive banking market provides better hedging against idiosyncratic shocks for lightly hit areas, but may lead to more severe freeze-up in bank lending for heavily hit areas where the shocks are more systemic. Evidences are provided suggesting that these real effects of banking market competition are generated through its impact on how supply/demand shocks on bank short-term funding are transmitted to banks’ short-term (retail/wholesale) liquidity prices. 

While the volume of cross-border capital inflow to emerging market economies (EMEs) has been increasing since 1970s, the last three decades has witnessed a more pronounced change in the structure of these cross-border capital flow. In this paper, we document the rise of domestic global banks in EMEs and the increasingly important role they play in channeling cross-border capital since 1990s. We further provide evidences suggesting that this structural change in the cross-border capital flow to EMEs is likely to be driven by the transformation in U.S. money market since the end of 1980s. Using detailed documentation on cross-border syndicated loans, we demonstrate that foreign and domestic lenders have drastically different preference on lending bases when extending credit to corporations in EMEs– foreign lenders exhibit much higher reluctance towards lending against hard assets as collateral. Based on the differentiated lending technologies, we show that the rise of domestic global banks in channeling cross-border capital to EMEs has a profound impact on i) who are receiving these capital and ii) how are these capital received. Inspired by these micro-level findings, we conduct a cross-country analysis and find that the rise of domestic global banks in transmitting cross-border capital to EMEs can generate profound real impact on these economies at the aggregate levels. In particular, we find that the rise of domestic global banks in EMEs can greatly i) reshape the industry structure of these economies and ii) increase the economies’ susceptibility to global financing cycles.  

Domestic banks in emerging market economies (EMEs) are playing an increasingly important role in transmitting cross-border credit to these economies. This paper proposes and empirically identifies a novel channel through which this structural change in cross-border credit flow generates welfare impact on the real economy. Through exploiting a unique cross-region heterogeneity of domestic global bank distribution in China, we investigate the real effects of the structural difference in cross-border credit across cities in China during the 2003-2009 global financing cycle. We find that regions in which a larger share of foreign credit being channeled by domestic banks are associated with more volatile real economic outcomes over the global financing cycle. Examination of deal level data on the lending relationships of domestic banks without access to international financial market reveals that a more susceptible domestic credit intermediation is a main driving force behind the excess real fluctuations. Furthermore, using disaggregate firm balance sheet data, we find that firms increase their tangible asset holding significantly during the easing phase of global financing cycle when access to domestic bank channeled foreign credit is available. This asset structure distorting behavior on firm side results in a larger plummet in price of fixed-value collateralizable assets when global financial condition tightens and leaves the local economy in more severe downturns. Our findings suggest that rise of domestic banks in the cross-border credit transmission to EMEs, which marks a completion in the contracting space by allowing cross-border credit contracts to be written against fixed-value domestic assets as collateral, is a mixed blessing to these economies. Increased flexibility in cross-border debt contracting allows hot money flowing to EMEs to be more efficiently allocated, but may lead to less efficient allocation of domestic credit when hot money leaves. 

We model financial innovations such as Exchange-Traded Funds, smart beta products, and many index-based vehicles as composite securities that facilitate trading common factors in assets’ liquidation values. Through accessing a larger basket of assets in endogenously-chosen proportions, composite securities can benefit both informed and liquidity traders and attract all factor investors with optimal designs that feature selecting liquid and representative assets. Consistent with empirical findings, introducing composite securities leads to higher price variability and co-movements, larger trading costs and synchronicity, and lower asset-specific but higher factor information in prices, especially for illiquid assets. Trading transparency, distinction between bundles and derivatives, and endogenous information acquisition also significantly affect prices and security design.

State-contingent control rights allow creditors to intervene after borrowers’ negative performance. Identifying the real value added by ex-post creditor intervention remains an empirical challenge due to the unknown counterfactual outcomes and the lack of randomly assigned treatment. In this paper, we investigate this question through examining an important form of renegotiation outcomes following covenant violations– the payment of amendment fee, which has been largely overlooked in the previous literature. Exploiting a hand-collected novel data on covenant amendments in corporate loan contracts, we first document the prevalence of nontrivial amendment fee payment made by borrowers in violation of covenants in exchange for waivers of covenant violations. We find that the amendment fee payment following covenant violation exhibits clear exclusiveness with explicit creditor intervention– only 6.9% covenant violations are followed by both amendment fee payments and creditor intervention on firm policy. This exclusiveness of amendment fee payment and creditor intervention suggests a potential time consistency issue in corporate debt contracting– creditors cannot commit to intervening after borrowers’ negative performance once been offered a side-payment for not doing so. We then examine factors that may affect the occurrence and the size of amendment fee payment following covenant violations. These factors include borrower side factors, creditor side factors and aggregate economic conditions. Eventually, we exploit variations in creditors’ share in borrowers’ outstanding liability as a measure of creditors’ skin-in-the-game to extract exogenous variations in the treatment assignment following covenant violations– whether or not interventions are undertaken. Using this instrumental variable, we identify a significantly positive real value added by creditors taking explicit actions intervening the operation of borrowers in covenant violations.