Some stylized facts about transactions among banks are not easily reconciled with coinsurance of short-term liquidity risks. In our model, interbank markets play a different role. We argue that lending to another bank can reduce a bank's overall portfolio risk through diversification. If...

We study efficiency properties of competitive economies in which banks provide liquidity insurance and interact on secondary asset markets. While all banks are subject to extrinsic risk, a bank's portfolio choice determines whether it is prone to a bank run in one of the extrinsic states. Asset...

A bank's decision on loan supply and capital structure determines its immediate bankruptcy risk as well as the future availability of internal funds. These internal funds in turn determine a bank's future costs of external finance and future vulnerability to bankruptcy risks. We study these...

We demonstrate that the co-existence of different motives for liquidity preferences profoundly affects the efficiency of financial intermediation. Liquidity preferences arise because consumers wish to take precautions against sudden and unforeseen expenditure needs, and because investors want to...