Regulation of Reserves and Interest Rates in a Model of Bank Runs
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 bankâ€™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.
|Date of creation:||15 Sep 2007|
|Date of revision:|
|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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