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Regulation of Reserves and Interest Rates in a Model of Bank Runs

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  • Geethanjali Selvaretnam

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Abstract

Banks fail because of bad economic fundamentals, or panic withdrawals by depositors. We show that even though there is no need for regulation when the bank’s policy regarding its solvency is transparent, there is indeed need for regulation if there is a lack of transparency. When the bank has private information, it chooses lower reserves and higher early returns than what maximises depositor welfare, which increases the probability of bank runs. Therefore the regulators should .x a maximum for early return and minimum for reserves. With transparency, there is excess reserves, and this inefficiency increases with the proportion of impatient agents.

Suggested Citation

  • Geethanjali Selvaretnam, 2007. "Regulation of Reserves and Interest Rates in a Model of Bank Runs," CDMA Working Paper Series 200714, Centre for Dynamic Macroeconomic Analysis.
  • Handle: RePEc:san:cdmawp:0714
    Note: This is a revised version of my paper "Optimal reserves and early returns in a model of bank runs" (University of Essex discussion paper 605, December 2005).
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    File URL: http://www.st-andrews.ac.uk/~wwwecon/CDMA/papers/wp0714.pdf
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    References listed on IDEAS

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    6. 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.
    7. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-781, December.
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    Cited by:

    1. Taufemback, Cleiton & Da Silva, Sergio, 2012. "Queuing theory applied to the optimal management of bank excess reserves," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 391(4), pages 1381-1387.

    More about this item

    Keywords

    Early return; global game; optimal reserves; regulation; transparency.;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • 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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