Bank Runs: Liquidity and Incentives / Russell Cooper, Thomas W. Ross.

Format:

Book

Author/Creator:

Cooper, Russell.

Contributor:

National Bureau of Economic Research.

Ross, Thomas W.

Series:

Working Paper Series (National Bureau of Economic Research) no. w3921.

NBER working paper series no. w3921

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Bank Runs

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1991.

Summary:

Diamond-Dybvig [1983] provide a model of intermediation in which bank runs are driven by pessimistic depositor expectations. Models which address these issues are important in the ongoing discussion which weighs the costs (incentive problems) and the benefits (preventing runs) of deposit insurance. In the present paper we extend the Diamond-Dybvig analysis to consider several important questions for evaluating deposit insurance that could not be addressed within their framework. First, we provide conditions for runs when banks can invest in both illiquid and liquid projects. This results in a weakening of the conditions necessary for bank runs relative to the Diamond-Dybvig model in which no liquid investments occur in equilibrium. Second, we characterize how banks respond to the possibility of runs in their design of deposit contracts and investment decisions, particularly through the holding of excess reserves. Finally, we use this framework to evaluate the costs and benefits of deposit insurance and other forms of intervention. To do so, we introduce moral hazard and monitoring into the model to explore the incentive effects of deposit insurance. The implementation of a capital requirement can, along with deposit insurance, support the optimal allocation.

Notes:

Print version record

November 1991.