Correlated bank runs, interbank markets and reserve requirements (original) (raw)
Related papers
2013
This article extends the application of global games of Goldstein and Pauzner (2005) in the banking model of Diamond and Dybvig (1983) to account for correlation in the quality of banksí long term investment, when banks are linked through cross deposits and there is a central bank. The goal is to study how these elements a§ect the deposit contract that banks o§er to depositors and the ex ante probability of a bank run. We show that the coexistence of a central bank, which determines banksí reserve requirements, and an interbank market, which redistributes reserves, leads to a smaller probability of a bank run and to less ine¢cient bank runs, relative to the case with no central bank and no interbank market. By adequately choosing the level of reserves to store, the central bank can improve the equilibrium outcome and allow banks to o§er a higher interim payment to depositors, relative to the situation with no cross deposits.
We analyze a banking system in which the class of feasible deposit contracts, or mechanisms, is broad. The mechanisms must satisfy a sequential service constraint, but partial or full suspension of convertibility is allowed. Consumers must be willing to deposit, ex ante. We show, by examples, that under the socalled "optimal contract," the post-deposit game can have a run equilibrium.
Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank
Journal of Money, Credit and Banking, 2000
We model systemic risk in an interbank market. Banks face liquidity needs as consumers are uncertain about where they need to consume. Interbank credit lines allow to cope with these liquidity shocks while reducing the cost of maintaining reserves. However, the interbank market exposes the system to a coordination failure (gridlock equilibrium) even if all banks are solvent. When one bank is insolvent, the stability of the banking system is affected in various ways depending on the patterns of payments across locations. We investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of one bank generates a chain reaction on the rest of the system. We analyze the coordinating role of the Central Bank in preventing payments systemic repercussions and we examine the justification of the Too-big-to-fail-policy.
Bank Portfolio Restrictions and Equilibrium Bank Runs
2003
We put the "runs" back in the bank runs literature. A unified bank, one that invests in both liquid and illiquid assets, is immune to runs but faces a relatively small probability of non-run rationing of depositors. In a separated financial system, the bank only holds relatively liquid assets; it is subject to runs with small probability, but because of its overinvestment in the liquid asset it is immune to non-run rationing of depositors. Surprisingly, legal restrictions on the bank's portfolio are either ineffective or they increase the fragility of the bank.
Bank runs and the optimality of limited banking
Review of Economic Dynamics, 2022
We extend the Diamond-Dybvig model of bank runs to include a specification of how much to deposit. When the propensity to run is zero, we prove an equivalence result, that the efficient allocation (satisfying resource, IC, and sequential service constraints) can be achieved in equilibrium as long as the deposit level is above a threshold. Within this range, the lower the deposit level, the more tempted patient depositors are to withdraw early. When the propensity to run is positive and certain conditions are met, the optimal banking system entails less than full deposits and runs on the equilibrium path. We extend the analysis to consider a propensity to run that depends on the risk factor of the run equilibrium.
An Empirical Model for Optimal Deposit Contracts; Liquidity and Bank–Runs
Journal of Instute of Science and Technology (IST)
In every country, policymakers erect a financial safety net to make systematic banking breakdowns less likely and to limit the disruption and fiscal costs generated when they occurs. This safety net includes implicit and explicit deposit insurance, lender-of-last-resort facilities at the central bank, procedures for investigating and resolving bank insolvencies, strategies for regulating and supervision banks and provisions for accessing emergency assistance from multinational institution etc. In this paper authors are trying to develop an empirical model that consider both liquid and illiquid assets of investment and set as optimal regarding the returns from both the institutions and investors point of view. They also focus on the aspect of institutional liquidity and the possible crises that might be the consequences and the model to overrun this likelihood to create the financial safety net.
Liquidity, moral hazard and bank runs
2007
In a model of banking with moral hazard, e¢cient risk-sharing between depositors may no longer be implementable. When depositors have all the bargaining power, we show that (i) with costless and perfect monitoring, contracts with the threat of bank runs o¤ the equilibrium path of play improve on contracts with transfers, (ii) when the bank's actions are non-contractible, equilibrium bank runs driven by incentives are linked to liquidity provision by banks. When the bank has all the bargaining power, there is production e¢ciency but no liquidity provision to depositors. The model is extended to allow for general monitoring scenarios and partial contractibility of the bank's payo¤s. Our results provide a theoretical foundation for the doctrine of "creative ambiguity ".
Optimal Bank Runs without Self-Fulfilling Prophecies
Econometric Society World Congress 2000 Contributed Papers, 2000
This paper extends the standard Diamond-Dybvig model for a general equilibrium in which depositors make their withdrawal decisions sequentially and banks strategically choose their contracts. There is a unique Subgame Perfect Nash Equilibrium SPNE in the decentralized economy. Bank runs can occur when depositors perceive a l o w return on bank assets. When information is imperfect, bank runs can happen even when the economy is in a good state. A representative bank can earn positive pro ts in equilibrium due to the sequential service constraint. When there are several risky projects available, the high-risk technology may b e c hosen as a socially e cient solution.
Bank Runs Without Self-fulfilling Prophecies
SSRN Electronic Journal, 2001
This paper proposes that bank runs are unique equilibrium outcomes instead of self-fulfilling prophecies. By assuming that depositors make their withdrawal decisions sequentially, the model provides an equilibrium-selection mechanism in the economy. A bank run would occur if and only if depositors perceive a low return on bank assets. Furthermore, a panic situation arises only when the market information is imperfect. A two-stage variant of the model shows that banks would deliberately offer a demand-deposit contract that is susceptive to bank runs. JEL Classification Numbers: G21, G14, C7 Keywords: bank runs, demand deposit, perfect Bayesian equilibrium BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS.
Bank Runs: The Predeposit Game
Macroeconomic Dynamics
We analyze in some detail the full predeposit game in a simple, tractable, yet very rich, banking environment. How does run-risk affect the optimal deposit contract? If there is a run equilibrium in the postdeposit game, then the optimal contract in the predeposit game tolerates small-probability runs. However, this does not mean that small changes in run-risk are ignored. In some cases, the optimal contract becomes—as one would expect—strictly more conservative as the run-probability increases (until it switches to the best run-proof contract), and the equilibrium allocation is not a mere randomization over the equilibrium allocations from the postdeposit game. In other cases, the allocation is a mere randomization over the equilibria from the postdeposit game. In the first cases (the more intuitive cases), the incentive constraint does not bind. In the second cases, the incentive constraint does bind.