On the Stability of Different Financial Systems
AbstractAn economy in which deposit-taking banks of a Diamond/Dybvig style and an asset market coexist is modelled. Firstly, within this framework we characterize distinct financial systems depending on the fraction of households with direct investment opportunities that are less efficient than those available to banks. With this fraction comparatively low, the evolving financial system can be interpreted as market-oriented. In this system, banks only provide efficient investment opportunities to households with inferior investment alternatives. Banks are not active in the secondary financial market nor do they provide any liquidity insurance to their depositors. Households participate to a large extent in the primary as well as in the secondary financial markets. In the other case of a relatively high fraction of households with inefficient direct investment opportunities, a bank-dominated financial system arises, in which banks provide liquidity transformation, are active in secondary financial markets and are the only player in primary markets, while households only participate in secondary financial markets. Secondly, we analyze the effect a run on a single bank has on the entire financial system. Interestingly, we can show that a bank run on a single bank causes contagion via the financial market neither in market- oriented nor in extremely bank-dominated financial systems. But in only moderately bank-dominated (or hybrid) financial systems fire sales of long-term financial claims by a distressed bank cause a sudden drop in asset prices that precipitates other banks into crisis.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0305008.
Length: 55 pages
Date of creation: 30 May 2003
Date of revision:
Note: Type of Document - PDF; pages: 55 ; figures: included
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Comparing financial systems; liquidity crises; financial fragility; bank runs; financial contagion;
Other versions of this item:
- Falko Fecht, 2003. "On the Stability of Different Financial Systems," Working Paper Series: Finance and Accounting 110, Department of Finance, Goethe University Frankfurt am Main.
- Fecht, Falko, 2003. "On the Stability of Different Financial Systems," Discussion Paper Series 1: Economic Studies 2003,10, Deutsche Bundesbank, Research Centre.
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-06-04 (All new papers)
- NEP-FIN-2003-06-04 (Finance)
- NEP-RMG-2003-06-04 (Risk Management)
- NEP-SEA-2003-06-04 (South East Asia)
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