The Welfare Costs of Self-Fulfilling Bank Runs

We study the welfare implications of self-fulfilling bank runs and liquidity require-ments, in a neoclassical growth model where banks, facing long-lasting possible runs, can choose in any period a run-proof asset portfolio. In this framework, runs distort banks’insurance provision against idiosyncratic liquidity shocks, and liquidity requirements re-solve this distortion by forcing a credit tightening. Quantitatively, the welfare costs of self-fulfilling bank runs are equivalent to a constant consumption loss of up to 2.5 percent of U.S. GDP. Depending on fundamentals, liquidity requirements might generate small welfare gains, but also increase the welfare costs by up to 1.8 percent.