Bank runs and institutions : the perils of intervention

American Economic Review (Impact Factor: 2.69). 02/2007; DOI: 10.2139/ssrn.2186651
Source: RePEc

ABSTRACT We study ex post efficient policy responses to a run on the banking system and the ex ante incentives these responses create. We show that the efficient response to a run is typically not to freeze all remaining deposits, since doing so imposes heavy costs on some individuals. Instead, once a run is underway, (benevolent) government institutions would allow additional deposit withdrawals, placing further strain on the banking system. When depositors anticipate these extra withdrawals, their incentive to participate in the run increases. In fact, ex post efficient interventions can generate the conditions necessary for a self-fulfilling run to occur.

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    ABSTRACT: We study credible information transmission by a benevolent Central Bank. We consider two possibilities: direct revelation through an announcement, versus indirect information transmission through monetary policy. These two ways of transmitting information have very dierent consequences. Since the objectives of the Central Bank and those of individual investors are not always aligned, private investors might ratio- nally ignore announcements by the Central Bank. In contrast, information transmission through changes in the interest rate creates a distortion, thus, lending an amount of credibility. This induces the private investors to rationally take into account informa- tion revealed through monetary policy. JEL classification: D80; E40; E52
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    ABSTRACT: A dynamic model is studied in which agents decide sequentially and observe a sample of past actions. Two decision-making ways are explored: agents either decide following a rule of thumb or they play only equilibrium strategies. When only the last actions are observed, independently of how decisions are made, bank run arises with probability 1. When samples are random, in the rule-of-thumb case unconditionally, while in the equilibrium approach under some conditions the probability of run is zero. JEL codes: C73, D03, G21
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    ABSTRACT: This research studies why commercial banks in the USA failed in the recent financial crisis from the aspect of risk taking by the financial institutions. First, lending risks come from the choice of illiquid assets that affect the quality of loans. Second, risk of securitisation is rooted in the implicit recourse, backstop of liquidity, balance sheet overexpansion, and the moral hazard problem. Third, the systemic risk from the overall economic conditions was ubiquitous when market liquidity intertwined with the funding liquidity. Indicators are provided that distinguish surviving banks from their failed peers which serve as the early warning signals that predict banking failures. Given that, this study provides policy options which will contribute to greater stability in the banking sector in a future financial market and economic crisis.
    International Journal of Financial Services Management 01/2013; 6(1):39-59.


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