Liquidity Shortages and Banking Crises / Douglas W. Diamond, Raghuram G. Rajan.

Format:

Book

Author/Creator:

Diamond, Douglas W.

Contributor:

National Bureau of Economic Research.

Rajan, Raghuram G.

Series:

Working Paper Series (National Bureau of Economic Research) no. w8937.

NBER working paper series no. w8937

Language:

English

Subjects (All):

Bank failures.

Bank liquidity.

Industrial productivity.

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2002.

Cambridge, Mass. : National Bureau of Economic Research, 2002.

Summary:

Banks can fail either because they are insolvent or because an aggregate shortage of liquidity can render them insolvent. We show that bank failures can themselves cause liquidity shortages. The failure of some banks can then lead to a cascade of failures and a possible total meltdown of the system. Contagion here is not caused by contractual or informational links between banks but because bank failure could lead to a contraction in the common pool of liquidity. There is a possible role for government intervention. Unfortunately, liquidity problems and solvency problems interact, and can each cause the other. It is therefore hard to determine the root cause of a crisis from observable factors. The practical difficulty of determining the most appropriate intervention, as well as the costs of the wrong kind of intervention (such as infusing capital when the need is for liquidity) have to be traded off against the costs of a meltdown, which can be substantial. We propose a robust sequence of intervention.

Notes:

Print version record

May 2002.