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Bank Runs and Investment Decisions Revisited

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  • Todd Keister
  • Huberto M. Ennis

Abstract

In this paper we extend the Cooper and Ross (1998) analysis of the optimal response of a competitive bank to the possibility of a bank run. If the probability of a run is small, the bank will offer a contract that admits a bank-run equilibrium. We show that, in this case, the bank will hold a quantity of liquid assets large enough to exactly meet withdrawal demand if a run does not occur; "excess" liquidity will not be held. This result allows us to determine how the possibility of a bank run affects the level of long-term investment chosen by a bank. We show that when the cost of liquidating investment early is high, the level of investment is decreasing in the probability of a run. However, when liquidation costs are smaller, the level of investment is actually increasing in the probability of a run.

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  • Todd Keister & Huberto M. Ennis, 2004. "Bank Runs and Investment Decisions Revisited," 2004 Meeting Papers 180, Society for Economic Dynamics.
    • Handle: RePEc:red:sed004:180
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    References listed on IDEAS

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    1. Green, Edward J. & Lin, Ping, 2003. "Implementing efficient allocations in a model of financial intermediation," Journal of Economic Theory, Elsevier, vol. 109(1), pages 1-23, March.
    2. Russell Cooper & Thomas Ross, 1991. "BANK RUNS: Liquidity and Incentives," Papers 0022, Boston University - Industry Studies Programme.
    3. Ennis, Huberto M. & Keister, Todd, 2005. "Government policy and the probability of coordination failures," European Economic Review, Elsevier, vol. 49(4), pages 939-973, May.
    4. Alejandro Gaytan & Romain Rancière, 2001. "Banks, liquidity crises and economic growth," Economics Working Papers 853, Department of Economics and Business, Universitat Pompeu Fabra, revised May 2003.
    5. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    6. Bruce Champ & Bruce D. Smith & Stephen D. Williamson, 1996. "Currency Elasticity and Banking Panics: Theory and Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 828-864, November.
    7. Freeman, Scott, 1988. "Banking as the Provision of Liquidity," The Journal of Business, University of Chicago Press, vol. 61(1), pages 45-64, January.
    8. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, vol. 109(2), pages 220-245, April.
    9. John H. Boyd & Pedro Gomis-Porqueras & Sungkyu Kwak & Bruce David Smith, 2014. "A User's Guide to Banking Crises," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 800-892, November.
    10. James Peck & Karl Shell, 2003. "Equilibrium Bank Runs," Journal of Political Economy, University of Chicago Press, vol. 111(1), pages 103-123, February.
    11. Neil Wallace, 1988. "Another attempt to explain an illiquid banking system: the Diamond and Dybvig model with sequential service taken seriously," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 12(Fall), pages 3-16.
    12. Caprio, Gerard Jr. & Klingebiel, Daniela, 1996. "Bank insolvencies : cross-country experience," Policy Research Working Paper Series 1620, The World Bank.
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    More about this item

    Keywords

    Bank runs;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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