Why do banks fund illiquid, informationally sensitive assets with short-term, often demandable debt? We develop a model in which banks' reliance on short-term debt makes their assets more liquid. Because banks monitor and collect information about borrowers, adverse selection makes it costly for them to raise new funds against their assets. Short-term debt forces banks to seek external funds whenever creditors demand liquidity, disguising their...

In opaque markets plagued by asymmetric information, firms borrow from many lenders at once and individual contracts are not observable to other lenders. We identify a novel information externality in a model based on such a setting. To avoid adverse selection, lenders use their private information to adjust the size of loans rather than the prices they offer to borrowers. Each lender's individual rationing decision...