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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 Diamond and Dybvig (1983) model so that, besides offering liquidity services to depositors, banks also raise equity funding, make loans that are risky, and can invest in safe, liquid assets. The bank and its borrowers are subject to limited liability. When profitable, banks monitor borrowers to ensure that they repay loans. Depositors may choose to run based on conjectures about the resources that are available for people withdrawing early and beliefs about banks’ monitoring. We use a new type of global game to solve for the run decision. We find that banks opt for a more deposit-intensive capital structure than a social planner would choose. The privately chosen asset portfolio can be more or less lending-intensive, while the scale of intermediation can also be higher or lower depending on a planner’s preferences between liquidity provision and credit extension. To correct these three distortions, a package of three regulations is warranted.

Suggested Citation

  • Anil K. Kashyap & Dimitrios P. Tsomocos & Alexandros P. Vardoulakis, 2020. "Optimal Bank Regulation In the Presence of Credit and Run-Risk," NBER Working Papers 26689, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:26689
    Note: CF ME
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    References listed on IDEAS

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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.

    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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