1. 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.

2. 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

3. 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!

4. 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

5. 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

6. 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

7. 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?

8. 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 