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On the Stability of Different Financial Systems

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  • Falko Fecht

    (Deutsche Bundesbank,)

Abstract

An economy in which deposit-taking banks of a Diamond and Dybvig style and a financial market coexist is modeled in a simple framework closely related to Diamond (1997). Solely depending on the fraction of naïve households who cannot efficiently invest directly in the cor-porate sector, two different types of financial systems emerge. With the fraction comparatively low, the evolving financial system can be interpreted as market-oriented, whereas a high frac-tion brings about a bank-dominated financial system. In market-oriented systems, banks only provide naïve households with access to efficient investments; in bank-dominated systems, banks' deposit contracts also offer some degree of liquidity insurance. Consequently, com-pared to market-oriented financial systems, the household sector in bank-dominated financial systems holds a larger portfolio fraction in deposits and a smaller part in direct investments. Analyzing the resilience of the different financial systems to various types of shocks shows that moderately bank-dominated (or hybrid) financial systems are particularly fragile, because only in these systems do fire sales of assets by distressed banks cause a deterioration in asset prices that also precipitates other banks into crisis. (JEL: D52, E44, G10, G21) Copyright (c) 2004 by the European Economic Association.

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Bibliographic Info

Article provided by MIT Press in its journal Journal of the European Economic Association.

Volume (Year): 2 (2004)
Issue (Month): 6 (December)
Pages: 969-1014

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Handle: RePEc:tpr:jeurec:v:2:y:2004:i:6:p:969-1014

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  1. Douglas W. Diamond & Raghuram G. Rajan, 1999. "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," NBER Working Papers 7430, National Bureau of Economic Research, Inc.
  2. Douglas W. Diamond & Raghuram G. Rajan, . "A Theory of Bank Capital," CRSP working papers 363, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  3. Allen, Franklin & Gale, Douglas, 1995. "A welfare comparison of intermediaries and financial markets in Germany and the US," European Economic Review, Elsevier, vol. 39(2), pages 179-209, February.
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  5. Douglas W. Diamond, . "Liquidity, Banks and Markets," CRSP working papers 326, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  6. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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  8. Franklin Allen & Douglas Gale, 2001. "Comparative Financial Systems: A Survey," Center for Financial Institutions Working Papers 01-15, Wharton School Center for Financial Institutions, University of Pennsylvania.
  9. Aghion, Philippe & Bolton, Patrick & Dewatripont, Mathias, 2000. "Contagious bank failures in a free banking system," European Economic Review, Elsevier, vol. 44(4-6), pages 713-718, May.
  10. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
  11. Schmidt, Reinhard H. & Hackethal, Andreas & Tyrell, Marcel, 1999. "Disintermediation and the Role of Banks in Europe: An International Comparison," Journal of Financial Intermediation, Elsevier, vol. 8(1-2), pages 36-67, January.
  12. Luigi Zingales & Raghuram G. Rajan, 2003. "Banks and Markets: The Changing Character of European Finance," NBER Working Papers 9595, National Bureau of Economic Research, Inc.
  13. Aghion, Philippe & Bolton, Patrick & Dewatripont, Mathias, 2000. "Contagious bank failures in a free banking system," Scholarly Articles 12490629, Harvard University Department of Economics.
  14. Alexandra Lai, 2002. "Modelling Financial Instability: A Survey of the Literature," Working Papers 02-12, Bank of Canada.
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