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Bank runs, liquidity and credit risk

  • Topi, Jukka

    ()

    (Bank of Finland Research)

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    In this paper, I develop a model that addresses the links between banks’ liquidity outlook and their incentives to take credit risk. Assuming that both bank-specific liquidity shocks and credit losses are necessary to provoke bank runs, the model predicts that a bank’s incentives to mitigate its credit risk by screening decrease if the probability of a bank-specific liquidity shock declines. This suggests that the benign liquidity outlook prevailing prior to the subprime crisis may have contributed to the lack of screening by banks that has been an important causal factor in the crisis.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0812netti.pdf
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    Paper provided by Bank of Finland in its series Research Discussion Papers with number 12/2008.

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    Length: 31 pages
    Date of creation: 14 May 2008
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2008_012
    Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/

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    1. Douglas W. Diamond & Raghuram G. Rajan, 1999. "A Theory of Bank Capital," NBER Working Papers 7431, National Bureau of Economic Research, Inc.
    2. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
    3. Chen, Yehning & Hasan, Iftekhar, 2006. "Why do bank runs look like panic? A new explanation," Research Discussion Papers 19/2006, Bank of Finland.
    4. Gale, D. & Allen, F., 1991. "Limited Market Participation and Volatility of Asset Prices," Weiss Center Working Papers 14-91, Wharton School - Weiss Center for International Financial Research.
    5. Alan Greenspan, 2005. "Central bank panel discussion: speech to the International Monetary Conference, Beijing, People's Republic of China (via satellite), June 6, 2005," Speech 120, Board of Governors of the Federal Reserve System (U.S.).
    6. Franklin Allen & Douglas Gale, 1976. "Optimal Financial Crises," Center for Financial Institutions Working Papers 97-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
    7. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    8. Franklin Allen & Douglas Gale, 2003. "Financial Intermediaries and Markets," Center for Financial Institutions Working Papers 00-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
    9. Nicolae B. Garleanu & Lasse H. Pedersen, 2007. "Liquidity and Risk Management," NBER Working Papers 12887, National Bureau of Economic Research, Inc.
    10. Douglas W. Diamond & Raghuram G. Rajan, . "Liquidity Risk, Liquidity Creation and Financial Fragility: A Theory of Banking," CRSP working papers 476, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    11. von Thadden, Ernst-Ludwig, 1998. "Intermediated versus Direct Investment: Optimal Liquidity Provision and Dynamic Incentive Compatibility," Journal of Financial Intermediation, Elsevier, vol. 7(2), pages 177-197, April.
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