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

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Author Info
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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Publisher Info
Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 0714.

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Date of creation: 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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Related research
Keywords: Early return; global game; optimal reserves; regulation; transparency.;

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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  3. 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. [Downloadable!] (restricted)
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  6. Bougheas, Spiros, 1999. "Contagious bank runs," International Review of Economics & Finance, Elsevier, vol. 8(2), pages 131-146, June. [Downloadable!] (restricted)
  7. Enrica Detragiache & Asli Demirgüç-Kunt, 1997. "The Determinants of Banking Crises - Evidence from Developing and Developed Countries," IMF Working Papers 97/106, International Monetary Fund.
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  12. 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. [Downloadable!]
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  13. 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. [Downloadable!] (restricted)
  14. Antonio E. Bernardo & Ivo Welch, 2004. "Liquidity and Financial Market Runs," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 135-158, February. [Downloadable!] (restricted)
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  15. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February. [Downloadable!] (restricted)
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