Banks choose the amounts of their r

Banks choose the amounts of their retail deposits and wholesale funding to maximize their profits. In equilibrium, the marginal product of lending is equal to the marginal cost of their retail deposits and that of their wholesale funding. As all banks face identical loan demand and retail deposit supply but different costs of wholesale funding, Bank 1, which faces fewer frictions, raises more wholesale funding than Bank 2 to originate more loans. In equilibrium, Bank 1 is hence more reliant on wholesale funding, defined as the ratio between wholesale funding and retail deposits. This is straight forward because the banks face the same deposit cost functions but different wholesale funding cost functions. Note that this suggests that Bank 1 will have a lower LCR, the ratio of high-quality liquid assets to expected net cash outflows, as retail deposits are assumed to be stickier than wholesale funding under the Basel III assumptions. Here, we obtain the following empirical prediction.