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Optimal Bank Regulation in the Presence of Credit and Run Risk

Author

Listed:
  • Anil K Kashyap
  • Dimitrios P. Tsomocos
  • Alexandros P. Vardoulakis

Abstract

We modify the 1983 Diamond and Dybvig model so that banks offer liquidity services to depositors, raise equity funding, make risky loans, and invest in safe, liquid assets. Banks monitor borrowers to ensure that they repay loans and they are susceptible to depositor runs. We model the run decision by solving a novel global game. Relative to a social planner, banks opt for a more deposit-intensive capital structure, their assets may be more or less lending intensive, and the level of lending may be higher or lower. Correcting these three distortions requires a package of three regulations.

Suggested Citation

  • Anil K Kashyap & Dimitrios P. Tsomocos & Alexandros P. Vardoulakis, 2024. "Optimal Bank Regulation in the Presence of Credit and Run Risk," Journal of Political Economy, University of Chicago Press, vol. 132(3), pages 772-823.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/726909
    DOI: 10.1086/726909
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    Cited by:

    1. Santos, João A.C. & Suarez, Javier, 2019. "Liquidity standards and the value of an informed lender of last resort," Journal of Financial Economics, Elsevier, vol. 132(2), pages 351-368.
    2. Natanael Waraney Gerald Massie & Chaikal Nuryakin, 2020. "When Prime Depositors Run On The Banks: A Behavioral Approach," Bulletin of Monetary Economics and Banking, Bank Indonesia, vol. 23(1), pages 139-152, April.
    3. Altermatt, Lukas & Wang, Zijian, 2024. "Oligopoly banking, risky investment, and monetary policy," European Economic Review, Elsevier, vol. 164(C).
    4. Kristian Blickle & Markus Brunnermeier & Stephan Luck, 2020. "Micro-evidence from a System-wide Financial Meltdown: The German Crisis of 1931," Working Papers 275, Princeton University, Department of Economics, Center for Economic Policy Studies..
    5. Anand, Kartik & König, Philipp Johann, 2026. "Multiple equilibria? Don't panic! - A hitchhiker's guide to global games," Discussion Papers 05/2026, Deutsche Bundesbank.
    6. Sundaresan, Suresh & Xiao, Kairong, 2024. "Liquidity regulation and banks: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 151(C).
    7. Roberts, Daniel & Sarkar, Asani & Shachar, Or, 2023. "Liquidity regulations, bank lending and fire-sale risk," Journal of Banking & Finance, Elsevier, vol. 156(C).
    8. Eric Cuijpers & Razvan Vlahu, 2026. "Cross-border banking, intragroup exposures and risk-taking," Working Papers 854, DNB.
    9. Porcellacchia, Davide & Sheedy, Kevin D., 2024. "The macroeconomics of liquidity in financial intermediation," Working Paper Series 2939, European Central Bank.
    10. Carletti, Elena & Leonello, Agnese & Marquez, Robert, 2023. "Loan guarantees, bank underwriting policies and financial stability," Journal of Financial Economics, Elsevier, vol. 149(2), pages 260-295.
    11. Gersbach, Hans & Haller, Hans & Zelzner, Sebastian, 2023. "Enough liquidity with enough capital - And vice versa?," CFS Working Paper Series 714, Center for Financial Studies (CFS).
    12. Altermatt, Lukas & van Buggenum, Hugo & Voellmy, Lukas, 2024. "Systemic bank runs without aggregate risk: How a misallocation of liquidity may trigger a solvency crisis," Journal of Financial Economics, Elsevier, vol. 161(C).
    13. Fabiana Gomez & Quynh-Anh Vo, 2020. "Liquidity management, fire sale and liquidity crises in banking: the role of leverage," Bank of England working papers 894, Bank of England.
    14. Kristian Blickle & Markus Brunnermeier & Stephan Luck, 2024. "Who Can Tell Which Banks Will Fail?," The Review of Financial Studies, Society for Financial Studies, vol. 37(9), pages 2685-2731.
    15. Manuel Amador & Javier Bianchi, 2024. "Bank Runs, Fragility, and Credit Easing," American Economic Review, American Economic Association, vol. 114(7), pages 2073-2110, July.
    16. de Bandt, Olivier & Lecarpentier, Sandrine & Pouvelle, Cyril, 2021. "Determinants of banks’ liquidity: A French perspective on interactions between market and regulatory requirements," Journal of Banking & Finance, Elsevier, vol. 124(C).
    17. Matt Darst & Sotirios Kokas & Alexandros Kontonikas & José-Luis Peydró & Alexandros Vardoulakis, 2025. "QE, Bank Liquidity Risk Management, and Non-Bank Funding: Evidence from U.S. Administrative Data," Finance and Economics Discussion Series 2025-030, Board of Governors of the Federal Reserve System (U.S.).
    18. Hibiki Ichiue & Jean-Guillaume Sahuc & Yasin Mimir & Jolan Mohimont & Kalin Nikolov & Olivier de Bandt & Sigrid Roehrs & Valério Scalone & Michael Straughan & Bora Durdu, 2022. "Assessing the Impact of Basel III: Evidence from Structural Macroeconomic Models," Working Papers hal-04159816, HAL.
    19. Martínez, J-F. & Peiris, M.U. & Tsomocos, D.P., 2020. "Macroprudential policy analysis in an estimated DSGE model with a heterogeneous banking system: An application to Chile," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 1(1).
    20. Lartey, Theophilus & James, Gregory A. & Danso, Albert, 2021. "Interbank funding, bank risk exposure and performance in the UK: A three-stage network DEA approach," International Review of Financial Analysis, Elsevier, vol. 75(C).
    21. Rafael Matta & Enrico Perotti, 2024. "Pay, Stay, or Delay? How to Settle a Run," The Review of Financial Studies, Society for Financial Studies, vol. 37(4), pages 1368-1407.
    22. Philippas, Dionisis & Tziogkidis, Panagiotis & Sfakianakis, Manos, 2025. "The fine line between ESG commitment and bank performance," Energy Economics, Elsevier, vol. 151(C).
    23. Raphaël Cardot-Martin & Fabien Labondance & Catherine Refait-Alexandre, 2022. "Capital ratios and banking crises in the European Union," International Economics, CEPII research center, issue 172, pages 389-402.
    24. Skander Van den Heuvel, 2019. "The Welfare Effects of Bank Liquidity and Capital Requirements," 2019 Meeting Papers 325, Society for Economic Dynamics.

    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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