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Bank runs and investment decisions revisited

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  • Ennis, Huberto M.
  • Keister, Todd

Abstract

We examine how the possibility of a bank run affects the deposit contract offered and the investment decisions made by a competitive bank. Cooper and Ross (1998) have shown that when the probability of a run is small, the bank will offer a contract that admits a bank-run equilibrium. We show that, in this case, the bank will chose to hold an amount of liquid reserves exactly equal to what withdrawal demand will be if a run does not occur. In other words, precautionary or \"excess\" liquidity will not be held. This result allows us to determine how the possibility of a bank run affects the level of illiquid investment chosen by a bank. We show that when the cost of liquidating investment early is high, the level of investment is decreasing in the probability of a run. However, when liquidation costs are moderate, the level of investment is actually increasing in the probability of a run.
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  • Ennis, Huberto M. & Keister, Todd, 2006. "Bank runs and investment decisions revisited," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 217-232, March.
    • Handle: RePEc:eee:moneco:v:53:y:2006:i:2:p:217-232
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    More about this item

    JEL classification:

    • 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
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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