DYNAMIC MATURITY TRANSFORATION

We develop an infinite horizon equilibrium model in which banks finance long term assets with non-tradable debt. Banks choose the amount of debt and its maturity taking into account investors’ preference for short maturities (which better accommodate their preference shocks) and the risk of systemic liquidity crises (during which refinancing is especially expensive). Unregulated debt maturities are inefficiently short due to pecuniary externalities in the market for funds during crises and their interaction with banks’ refinancing constraints. We show the possibility of improving welfare by means of limits to debt maturity, Pigovian taxes, and private and public liquidity insurance schemes.