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

  • Geethanjali Selvaretnam

    ()

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.

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File URL: http://www.st-andrews.ac.uk/economics/CDMA/papers/wp0714.pdf
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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200714.

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Date of creation: 15 Sep 2007
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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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  1. Clouse, James A. & Dow, James Jr., 2002. "A computational model of banks' optimal reserve management policy," Journal of Economic Dynamics and Control, Elsevier, vol. 26(11), pages 1787-1814, September.
  2. Antonio E. Bernardo & Ivo Welch, 2004. "Liquidity and Financial Market Runs," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 135-158, February.
  3. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
  4. Stephen Morris & Hyun Song Shin, 2000. "Global Games: Theory and Applications," Cowles Foundation Discussion Papers 1275R, Cowles Foundation for Research in Economics, Yale University, revised Aug 2001.
  5. Gorton, Gary, 1988. "Banking Panics and Business Cycles," Oxford Economic Papers, Oxford University Press, vol. 40(4), pages 751-81, December.
  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. Peck, James & Shell, Karl, 2001. "Equilibrium Bank Runs," Working Papers 01-10r, Cornell University, Center for Analytic Economics.
  8. Bougheas, Spiros, 1999. "Contagious bank runs," International Review of Economics & Finance, Elsevier, vol. 8(2), pages 131-146, June.
  9. Carlsson, H. & Van Damme, E., 1990. "Global Games And Equilibrium Selection," Papers 9052, Tilburg - Center for Economic Research.
  10. Cooper, Russell & Ross, Thomas W., 1998. "Bank runs: Liquidity costs and investment distortions," Journal of Monetary Economics, Elsevier, vol. 41(1), pages 27-38, February.
  11. Asli Demirgüç-Kunt & Enrica Detragiache, 1997. "The Determinants of Banking Crises; Evidence From Developing and Developed Countries," IMF Working Papers 97/106, International Monetary Fund.
  12. Bhattacharya, S. & Boot, A.W.A. & Thakor, A.V., 1995. "The Economics of Bank Regulation," Papers 9516, Centro de Estudios Monetarios Y Financieros-.
  13. Loewy, Michael B., 1998. "Information-Based Bank Runs in a Monetary Economy," Journal of Macroeconomics, Elsevier, vol. 20(4), pages 681-702, October.
  14. Itay Goldstein & Ady Pauzner, 2005. "Demand-Deposit Contracts and the Probability of Bank Runs," Journal of Finance, American Finance Association, vol. 60(3), pages 1293-1327, 06.
  15. repec:ner:tilbur:urn:nbn:nl:ui:12-154416 is not listed on IDEAS
  16. Alonso, Irasema, 1996. "On avoiding bank runs," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 73-87, February.
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