Equilibrium Collateral Constraints

I study a model in which banks need to borrow to make risky loans whose return is private information known only by the bank who made the loan. To raise funds, banks can either sell assets or pledge them as collateral. I show that collateral contracts arise in equilibrium even though all agents would value the asset the same in autarky. The persistence in the role as borrowers or lenders and the banks' ability to make a profits from loans imply that banks will value the asset more than lenders. On top of paying dividends, the asset resolves the banks' maturity mismatch problem and, since it is used as collateral, it relaxes a borrowing constraint. The amount that can be borrowed against the asset is determined in equilibrium. I show that increases in risk may decrease the asset's debt capacity and, thus, the level of intermediation in the economy.