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A Theory of Banking Crises (Part 1)

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  • Keiichiro Kobayashi

Abstract

In order to protect the public's confidence in deposit money, governments usually guarantee bank deposits implicitly or through an explicit deposit insurance system. Thus bank insolvency does not induce immediate bank runs. In many episodes of banking crises, several years passed quietly after bank insolvency had occurred, with the insolvency continuing to develop under the surface, and the rash of bank failures broke out only when the bank insolvency exceeded a certain level. In this paper I present a simple model that describes the dynamics of bank insolvency in a form that eventually results in banking system failure or bank recapitalization by the government. The main results are as follows: (1) The government cannot indefinitely postpone recognizing the fiscal loss associated with bank insolvency. (2) The consumption level is too high (low) before (after) bank recapitalization compared with the optimal level. Thus the price conditions become deflationary (inflationary) before (after) bank recapitalization. (3) Social welfare decreases as bank recapitalization is delayed.

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Paper provided by Research Institute of Economy, Trade and Industry (RIETI) in its series Discussion papers with number 03016.

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Length: 15 pages
Date of creation: Jul 2003
Date of revision:
Handle: RePEc:eti:dpaper:03016

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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. John H. Boyd & Pedro Gomis & Sungkyu Kwak & Bruce D. Smith, 2000. "A User's Guide to Banking Crises," Development Research Unit Working Paper Series archive-36, Monash University, Department of Economics.
  3. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  4. Dekle, Robert & Kletzer, Kenneth, 2003. "The Japanese banking crisis and economic growth: Theoretical and empirical implications of deposit guarantees and weak financial regulation," Journal of the Japanese and International Economies, Elsevier, vol. 17(3), pages 305-335, September.
  5. Honohan, Patrick & Klingebiel, Daniela, 2000. "Controlling the fiscal costs of banking crises," Policy Research Working Paper Series 2441, The World Bank.
  6. Calvo, Guillermo A, 1987. "Balance of Payments Crises in a Cash-in-Advance Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(1), pages 19-32, February.
  7. John H. Cochrane, 2000. "Money as Stock: Price Level Determination with no Money Demand," NBER Working Papers 7498, National Bureau of Economic Research, Inc.
  8. Guillermo A. Calvo, 2003. "Explaining Sudden Stops, Growth Collapse and BOP Crises: The Case of Distortionary Output Taxes," NBER Working Papers 9864, National Bureau of Economic Research, Inc.
  9. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
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Cited by:
  1. Keiichiro Kobayashi, 2003. "Deflation Caused by Bank Insolvency," Discussion papers 03022, Research Institute of Economy, Trade and Industry (RIETI).

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