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Banking Structures, Liquidity and Macroeconomic Stability

Author

Listed:
  • Araujo, Luis

    (Michigan State University, Department of Economics)

  • Hong, David

    (Michigan State University, Department of Economics)

  • Kokas, Sotirios

    (University of Essex)

  • Minetti, Raoul

    (Michigan State University, Department of Economics)

Abstract

Banking is increasingly a complex activity. We investigate the output and welfare consequences of banking structures in an economy where lenders use information to screen investment quality and to recover value from failed investments. Complex banking (lenders’ joint production of information) eases information production but also facilitates the detection and liquidation of fragile investments. We find that complex banking enhances the resilience to small investment shocks but can amplify the output and welfare responses to large negative shocks. A larger complexity of investments preserves the stabilizing properties of complex banking following small shocks, but increases the chances that complex banking harms welfare after large shocks. The predictions are broadly consistent with evidence from matched bank-firm US data.

Suggested Citation

  • Araujo, Luis & Hong, David & Kokas, Sotirios & Minetti, Raoul, 2022. "Banking Structures, Liquidity and Macroeconomic Stability," Working Papers 2022-4, Michigan State University, Department of Economics.
    • Handle: RePEc:ris:msuecw:2022_004
    as

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    File URL: http://econ.msu.edu/repec/wp/Complex_Banking_Project.pdf
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    References listed on IDEAS

    as
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    5. Douglas W. Diamond & Raghuram G. Rajan, 2001. "Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking," Journal of Political Economy, University of Chicago Press, vol. 109(2), pages 287-327, April.
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    More about this item

    Keywords

    Information; Banking; Investment Complexity;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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