Procyclical Leverage and Crisis Probability in a Macroeconomic Model of Bank Runs

Banking crises are infrequent events nested in financial cycles, often preceded by credit expansions and high bank leverage, and followed by prolonged recessions with substantial declines in investment. To explain these facts, we develop a dynamic general equilibrium model of bank runs with two features: a global game approach and sticky bank capital. The model generates procyclical bank leverage and run probability that increases during credit and economic expansions. A negative productivity shock triggers a run, which is often followed by another run, making recessions deeper and longer. Macroprudential policy that curbs procyclical leverage makes banking crises less frequent.