Capital Structure, Agency Problems, and Deposit Insurance in Banking Firms

This paper applies and synthesizes various theories of corporate finance, including capital structure, agency insurance, and regulation, to the case of banking firms and the deposit insurance system. It is argued that a value-maximizing bank would reach its optimal capital structure by minimizing the agency costs of incentive conflicts among stockholders, managers, uninsured depositors, and the deposit insurance agency. Although a regulatory imposed capital requirement may reduce the agency costs inherent in the insurance contract, it cannot produce a universal capital structure that is optimal for all insured banks. The observed capital structure patterns also suggest that banks actively seek an optimal capital structure.