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Preventing bank runs

Author

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  • David Andolfatto
  • Ed Nosal
  • Bruno Sultanum

Abstract

Diamond and Dybvig (1983) is commonly understood as providing a formal rationale for the existence of bank-run equilibria. It has never been clear, however, whether bank-run equilibria in this framework are a natural byproduct of the economic environment or an artifact of suboptimal contractual arrangements. In the class of direct mechanisms, Peck and Shell (2003) demonstrate that bank-run equilibria can exist under an optimal contractual arrangement. The difficulty of preventing runs within this class of mechanism is that banks cannot identify whether withdrawals are being driven by psychology or by fundamentals. Our solution to this problem is an indirect mechanism with the following two properties. First, it provides depositors an incentive to communicate whether they believe a run is on or not. Second, the mechanism threatens a suspension of convertibility conditional on what is revealed in these communications. Together, these two properties can eliminate the prospect of bank-run equilibria in the Diamond-Dybvig environment.

Suggested Citation

  • David Andolfatto & Ed Nosal & Bruno Sultanum, 2014. "Preventing bank runs," Working Papers 2014-21, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2014-021
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    References listed on IDEAS

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    1. Andolfatto, David & Nosal, Ed & Wallace, Neil, 2007. "The role of independence in the Green-Lin Diamond-Dybvig model," Journal of Economic Theory, Elsevier, vol. 137(1), pages 709-715, November.
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    Cited by:

    1. David Andolfatto & Ed Nosal, 2020. "Shadow Bank Runs," Working Papers 2020-012, Federal Reserve Bank of St. Louis.
    2. Li, Yang, 2017. "Interest rates and financial fragility," Journal of Economic Dynamics and Control, Elsevier, vol. 82(C), pages 195-205.
    3. Huberto Ennis & Todd Keister, 2016. "Optimal banking contracts and financial fragility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 61(2), pages 335-363, February.
    4. Hubert J. Kiss & Ismael Rodriguez-Lara & Alfonso Rosa-Garcia, 2021. "Experimental Bank Runs," ThE Papers 21/03, Department of Economic Theory and Economic History of the University of Granada..
    5. David Andolfatto & Ed Nosal, 2017. "Bank Panics and Scale Economies," Working Papers 2017-9, Federal Reserve Bank of St. Louis.
    6. Sultanum, Bruno, 2018. "Financial fragility and over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 177(C), pages 616-658.
    7. Parnes, Dror, 2021. "Modeling the contagion of bank runs with a Markov model," The Quarterly Review of Economics and Finance, Elsevier, vol. 81(C), pages 174-187.
    8. Donaldson, Jason Roderick & Piacentino, Giorgia, 2019. "Money Runs," CEPR Discussion Papers 13955, C.E.P.R. Discussion Papers.
    9. David Andolfatto & Ed Nosal, 2018. "Bank runs without sequential service," Working Papers 2018-16, Federal Reserve Bank of St. Louis.
    10. Markus Kinateder & Hubert Janos Kiss & Agnes Pinter, 2015. "Would depositors like to show others that they do not withdraw? Theory and Experiment," CERS-IE WORKING PAPERS 1553, Institute of Economics, Centre for Economic and Regional Studies.
    11. Natalia V. Koshel, 2018. "More than Supervision: Identifying Opportunistic Bank Behavior through Marketing Tools," European Research Studies Journal, European Research Studies Journal, vol. 0(Special 2), pages 144-157.
    12. Bucher, Monika & Dietrich, Diemo & Tvede, Mich, 2018. "Coordination failures, bank runs and asset prices," Discussion Papers 39/2018, Deutsche Bundesbank.
    13. Fernando Martin & Aleksander Berentsen & David Andolfatto, 2016. "Financial Fragility in Monetary Economies," 2016 Meeting Papers 1626, Society for Economic Dynamics.
    14. Simas Kucinskas, 2015. "Liquidity Creation without Banks," Tinbergen Institute Discussion Papers 15-101/VI, Tinbergen Institute.
    15. Simas Kucinskas, 2015. "Liquidity creation without banks," DNB Working Papers 482, Netherlands Central Bank, Research Department.
    16. Bruno Sultanum, 2021. "The Cost of Information in the Blockchain: A Discussion of Routledge and Zetlin-Jones," Working Paper 21-02, Federal Reserve Bank of Richmond.
    17. Roberto Robatto, 2015. "Financial Crises and Systemic Bank Runs in a Dynamic Model of Banking," 2015 Meeting Papers 483, Society for Economic Dynamics.
    18. Jason R. Donaldson & Giorgia Piacentino, 2019. "Money Runs," NBER Working Papers 26298, National Bureau of Economic Research, Inc.
    19. Zhen Zhou & Deepal Basak, 2015. "Diffusing Coordination Risk," 2015 Meeting Papers 1350, Society for Economic Dynamics.
    20. Kučinskas, Simas, 2019. "Aggregate risk and efficiency of mutual funds," Journal of Banking & Finance, Elsevier, vol. 101(C), pages 1-11.

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    More about this item

    Keywords

    bank runs; optimal deposit contract; financial fragility;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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