We describe a model in which bank deposits yield liquidity services and therefore earn a lower rate of return than equity. In this sense, deposits are a cheaper source of funding for banks than equity. The banks' equilibrium capital structure is determined by a trade off between the funding...

While systemic risk—the risk of wholesale failure of banksand other financial institutions—is generally consideredto be the primary reason for supervision and regulation of thebanking industry, almost all regulatory rules treat such risk inisolation. In particular, they do not account for...