Creditors are tempted to examine collateral assets of uncertain value, but costly information acquisition ultimately reduces financing capacity. A pecking order emerges. Debt provides greater financing capacity than equity: unlike equity, creditors own the asset only if the borrower defaults, discouraging costly asset examination. Probabilistic asset ownership can be further diluted by introducing intermediaries between borrower and creditor, leading to a new theory of financial intermediation and credit chains. Our theory rationalizes the seemingly excessive complexity of financial architecture: the optimal chain arises in a decentralized equilibrium and is characterized by a sequence of heterogeneous intermediaries that discourages information production.

Contagion has been a central theme in episodes of bank fragility over the years. Yet, it is challenging to identify in the data. We provide evidence from the universe of banks in the US over the last three decades, showing how deposit outflows are associated with performance deterioration in peer banks. We then demonstrate how this is amplified by panic that is caused by the liquidity transformation in focal banks, peer banks, and the interaction between them. Our analysis speaks to the important role of liquidity transformation, generating panic that is amplifying and spreading financial fragilities across banks.

Households' increased allocation of savings outside banks raises the question of how this shift occurs and its effects on the banking sector. We show that local expansion of brokerage intermediation, measured as the local presence of securities brokers, reallocates household savings away from bank deposits. Using a staggered adoption of the Broker Protocol in a shift-share instrumental variables design, we find that a 1 percentage point increase in brokerage intermediation reduces bank deposits by 2.4 percent. These outflows coincide with higher local equity wealth, and banks do not offset by offering higher deposit rates or increasing funding from alternative sources. Banks that are more exposed to brokerage intermediation reduce small business lending. The results are not explained by stock market performance alone. Instead, they highlight a novel link between the evolving financial system and household portfolio allocation.