Forward credit commitments and bank behavior under uncertainty: Implications for monetary control

In this paper, we present bank behavior under uncertainty in a framework that incorporates bank forward credit commitments as well as its decisions regarding the desired level of deposits. We consider two sources of uncertainty: the level of cash withdrawals and the actual exercise of credit lines. Optimal bank behavior is analyzed within this framework. It is shown that the bank's defensive coverage (the ratio between its desired level of deposits and credit commitments) is independent of the level of credit commitments. Furthermore, this ratio is shown to be determined by the distribution of cash withdrawals, but is independent of the distribution of credit exercise. The optimal level of credit commitments is shown to depend on the distribution of cash withdrawals and the mean of credit exercise. What is more important, in most cases the effect of government policies on optimal bank behavior cannot be unambiguously assessed. Furthermore, the government may find it difficult to simultaneously achieve both lower credit commitments and improved bank solvency.