Asset Encumbrance, Bank Funding, and Financial Fragility

How does asset encumbrance affect the fragility of intermediaries subject to rollover risk? We offer a model of covered bonds that features the bankruptcy remoteness and replenishment of the asset pool that backs secured funding. Encumbering assets allows a bank to raise cheap secured debt and expand profitable investment, but it also concentrates risk on unsecured debt and thus exacerbates fragility. Deposit insurance or guarantees induce excessive encumbrance, shifting risks to the deposit insurance fund or the guarantor. Prudential regulation to correct this negative externality are limits on encumbrance, capital requirements, and surcharges on deposit insurance premia.