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Working Paper

Portfolio Risks and Bank Asset Choice

This paper investigates the effects of both credit risk and interest-rate risk on bank portfolio choices. It presents a model of banking that explains portfolio risks with informational asymmetries; depositors cannot observe the returns on bank loans and banks cannot observe depositors’ liquidity needs. - Bank capital must cover possible losses due to loan default and high future deposit costs given the maturity imbalance of bank portfolios. We show how bank capital inadequacy may prevent a bank from investing in the optimal portfolio and how the efficiency of the bank’s intermediation technology affects its choice of second-best portfolio.

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Samolyk, Katherine. 1989. “Portfolio Risks and Bank Asset Choice.” Federal Reserve Bank of Cleveland, Working Paper No. 89-13.