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Regulation of Reserves and Interest Rates in a Model of Bank Runs

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  • Geethanjali Selvaretnam

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Abstract

Banks fail because of bad economic fundamentals, or panic withdrawals by depositors. We show that even though there is no need for regulation when the bank’s policy regarding its solvency is transparent, there is indeed need for regulation if there is a lack of transparency. When the bank has private information, it chooses lower reserves and higher early returns than what maximises depositor welfare, which increases the probability of bank runs. Therefore the regulators should .x a maximum for early return and minimum for reserves. With transparency, there is excess reserves, and this inefficiency increases with the proportion of impatient agents.

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Bibliographic Info

Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200714.

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Date of creation: 15 Sep 2007
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Handle: RePEc:san:cdmawp:0714

Note: This is a revised version of my paper "Optimal reserves and early returns in a model of bank runs" (University of Essex discussion paper 605, December 2005).
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Keywords: Early return; global game; optimal reserves; regulation; transparency.;

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References

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  1. Antonio Bernardo & Ivo Welch, 2006. "Liquidity and Financial Market Runs," Yale School of Management Working Papers ysm280, Yale School of Management, revised 01 Aug 2003.
  2. Bhattacharya, S. & Boot, A.W.A. & Thakor, A.V., 1995. "The Economics of Bank Regulation," Papers 9516, Centro de Estudios Monetarios Y Financieros-.
  3. Carlsson, H. & Van Damme, E., 1990. "Global Games And Equilibrium Selection," Papers 9052, Tilburg - Center for Economic Research.
  4. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
  5. Cooper, Russell & Ross, Thomas W., 1998. "Bank runs: Liquidity costs and investment distortions," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 27-38, February.
  6. Itay Goldstein & Ady Pauzner, 2005. "Demand-Deposit Contracts and the Probability of Bank Runs," Journal of Finance, American Finance Association, vol. 60(3), pages 1293-1327, 06.
  7. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-97, June.
  8. Bougheas, Spiros, 1999. "Contagious bank runs," International Review of Economics & Finance, Elsevier, vol. 8(2), pages 131-146, June.
  9. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  10. Loewy, Michael B., 1998. "Information-Based Bank Runs in a Monetary Economy," Journal of Macroeconomics, Elsevier, vol. 20(4), pages 681-702, October.
  11. Stephen Morris & Hyun S Shin, 2001. "Global Games: Theory and Applications," Levine's Working Paper Archive 122247000000001080, David K. Levine.
  12. Asli Demirgüç-Kunt & Enrica Detragiache, 1997. "The Determinants of Banking Crises," IMF Working Papers 97/106, International Monetary Fund.
  13. Peck, James & Shell, Karl, 2001. "Equilibrium Bank Runs," Working Papers 01-10r, Cornell University, Center for Analytic Economics.
  14. Alonso, Irasema, 1996. "On avoiding bank runs," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 73-87, February.
  15. Clouse, James A. & Dow, James Jr., 2002. "A computational model of banks' optimal reserve management policy," Journal of Economic Dynamics and Control, Elsevier, vol. 26(11), pages 1787-1814, September.
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Cited by:
  1. Taufemback, Cleiton & Da Silva, Sergio, 2011. "Queuing theory applied to the optimal management of bank excess reserves," MPRA Paper 33529, University Library of Munich, Germany.

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