CKGSB Dean’s Distinguished Chair Professor of Finance and Senior Associate Dean, Wang Neng, has published a research paper “Dynamic Banking and the Value of Deposits” in the Journal of Finance, one of the world’s most prestigious academic journals in the field of Finance.
The paper, co-authored with Patrick Bolton of Imperial College London, Ye Li of the University of Washington, and Jinqiang Yang of Shanghai University of Finance and Economics, introduces a novel framework for understanding how banks manage their balance sheets in the face of unpredictable deposit flows.
A New Perspective on Banking Dynamics
Professor Wang’s research addresses a fundamental question that became particularly relevant during the COVID-19 pandemic: How do banks manage their balance sheets when faced with massive deposit inflows? Contrary to traditional banking models that focus primarily on the risks of deposit outflows (bank runs), this research highlights how deposit inflows can also create significant challenges for banks under certain conditions.
“We propose a theory of banking in which banks cannot perfectly control deposit flows,” the authors write in their abstract. “Facing uninsurable loan and deposit shocks, banks dynamically manage lending, wholesale funding, deposits, and equity.”
Key Findings
The paper introduces several key concepts to banking theory. First, it demonstrates that deposits create value for banks by lowering funding costs, but this value can turn negative when a bank is undercapitalized and at risk of breaching leverage requirements. In such situations, deposit inflows can increase leverage and the likelihood of costly equity issuance.
Second, the research develops a dynamic model showing how banks adjust their deposit rates to attract or repel deposits based on their current balance sheet condition. When a bank is well-capitalized, it raises deposit rates to attract more deposits as a source of cheap financing. When undercapitalized, it lowers rates to discourage further deposit inflows.
Third, the paper highlights how regulatory constraints, particularly leverage regulations like the Supplementary Leverage Ratio (SLR), interact with deposit flows to influence bank behavior. This became especially relevant during the COVID-19 pandemic when U.S. banks experienced unprecedented deposit inflows, leading regulators to temporarily relax the SLR requirement.
Fourth, the research reveals how the prevailing interest rate environment critically affects banks’ ability to manage deposit flows. In low interest rate environments, banks have less flexibility to adjust deposit rates downward, making them more vulnerable to unwanted deposit inflows.
Real-World Relevance
The paper’s findings have immediate practical applications, explaining several puzzling phenomena observed during the COVID-19 pandemic.
During the early stages of the pandemic, major U.S. banks experienced massive deposit inflows—JP Morgan Chase saw an 18% increase in its deposit base from Q4 2019 to Q1 2020, while Citigroup and Bank of America saw increases of 11% and 10%, respectively. Yet contrary to conventional wisdom, these deposit inflows did not increase bank valuations or stimulate lending.
The research explains this paradox: when banks are concerned about high leverage and potential costly equity issuance, deposit inflows can dampen their incentive to lend. This provides a theoretical foundation for understanding why banks did not increase lending despite the influx of deposits during the pandemic.
The paper also explains the dramatic increase in the Federal Reserve’s reverse repo facility following the restoration of the SLR requirement in April 2021. As the authors note, within three months of the SLR exemption ending, the outstanding amount in the reverse repo facility rose from almost zero to one trillion dollars, as banks encouraged depositors to move money to money market funds.
Professor Wang’s Contribution to Financial Research
This publication adds to Professor Wang Neng’s impressive record of academic achievement in finance. As a Distinguished Dean’s Chair Professor and Academic Senior Associate Dean at CKGSB, Professor Wang has established himself as a leading authority in financial economics. Before joining CKGSB, Professor Wang was a tenured professor with an endowed professorship at Columbia University’s Business School, where he was promoted to full professor at an exceptionally young age, becoming the youngest tenured full professor at Columbia Business School at that time.
His research spans multiple areas including consumer finance, corporate finance, entrepreneurial finance, macroeconomics, international finance, asset pricing theory, and financial technology. He has published numerous papers in top-tier academic journals in Economics, Finance, and Business and has received prestigious awards such as the Smith-Breeden Distinguished Paper Award from the Journal of Finance.
The Journal of Finance, established in 1946, is the official publication of the American Finance Association and ranks among the most influential academic journals in business and finance. With a 2021 impact factor of 7.870, publication in this journal represents recognition at the highest level of academic achievement in the field.
Access Professor Wang’s pre-published version of his Journal of Finance paper: HERE.
