Bank Opacity and Safe Asset Moneyness

Q1. Why does higher ROE lower the moneyness of a bank’s safe assets?

Higher ROE signals that a bank is more likely to be engaging in riskier investment activities with higher return volatility, which exposes safe asset investors—who care almost entirely about the left tail of the bank asset value distribution—to a higher likelihood of complete insolvency, lowering the moneyness of the bank’s debt. The intuition is asymmetric: for a debt holder, the upside is limited to the contracted interest rate, while the downside involves potential total loss if the bank becomes insolvent. A higher ROE thus signals higher left-tail risk rather than higher credit quality from the safe asset investor’s perspective, contradicting the positive signal that higher ROE sends to equity investors.

Q2. How does the model formalize the moneyness concept?

In the three-period model, the bank issues a money-like safe asset (deposit) to finance itself, and the household holds it both to transfer wealth intertemporally and to use it as a medium of exchange; moneyness captures both the safety and the liquidity of the asset as experienced by the holder. The model embeds the Gorton-Pennacchi (1990) and Dang-Gorton-Holmström (2012) notion that money-like assets are purposefully designed to be information-insensitive, so that investors have little incentive to acquire private information about them. The model shows how ROE—a piece of public information—nonetheless predicts moneyness and triggers withdrawal.

Q3. Why is bank opacity an equilibrium feature that improves moneyness?

Bank opacity mitigates the predictive power of ROE for the moneyness of safe assets because if investors cannot observe detailed information about the bank’s asset side, they cannot fully infer the riskiness of the investments backing the bank’s debt from the ROE signal, making it optimal for the banking system to maintain a certain level of opacity to preserve the information-insensitive character of its safe assets. This result is consistent with Dang et al. (2017)’s argument that banks are intentionally opaque: opacity is not merely a byproduct of complexity but a deliberate design feature that preserves the moneyness of privately produced safe assets.

Q4. What is the empirical evidence using MMF and dealer bank data?

Empirical tests using data on MMF funding of dealer banks confirm that higher bank ROE leads to MMF withdrawal from the bank, consistent with the model’s prediction that higher ROE reduces the moneyness of the bank’s safe assets for institutional investors; the relationship is attenuated for more opaque banks, consistent with the model’s opacity mechanism. The wholesale banking sector (dealer banks and institutional investors like MMFs) is the natural testing ground because its participants are more informed than retail depositors and therefore more sensitive to signals about the riskiness of the assets backing the bank’s debt.

Key concepts

moneyness of safe assets : the degree to which a financial asset is safe and liquid—traded at par with no questions asked; determined in this paper by how well a bank’s debt protects investors against the left tail of the bank asset value distribution. return on equity (ROE) as a risk signal : the paper’s key insight that, for safe asset investors (debt holders), higher bank ROE signals riskier investments with higher return volatility rather than lower credit risk; this contrasts with the positive signal ROE sends to equity investors. information-insensitive safe asset : a financial asset purposefully designed to be immune to private information acquisition by investors (Gorton-Pennacchi 1990; Dang et al. 2012); bank opacity preserves this property by limiting investors’ ability to infer asset-side risk from public signals.