Real Interest Rates, Bank Borrowing, and Fragility

How do real interest rates aﬀect ﬁnancial fragility? We study this issue in a model in which bank borrowing is subject to rollover risk. A bank’s optimal borrowing trades oﬀ the beneﬁt from investing additional funds into proﬁtable assets with the cost of greater risk of a run by bank creditors. Changes in the interest rate aﬀect the price and amount of borrowing, both of which inﬂuence bank fragility in opposite directions. Thus, the marginal impact of changes to the interest rate on bank fragility depends on the level of the interest rate. Finally, we derive testable implications that may guide future empirical work.