Bank risk within and across equilibria

Itai Agur

Journal of Banking & Finance, 2014, vol. 48, issue C, 322-333

Abstract: The global financial crisis highlighted that the financial system can be most vulnerable when it seems most stable. This paper models non-linear dynamics in banking. Small shocks can lead from an equilibrium with few bank defaults straight to a full freeze. The mechanism is based on amplification between adverse selection on banks’ funding market and moral hazard in bank monitoring. Our results imply trade-offs between regulators’ microprudential desire to shield individual weak banks and the macroprudential consequences of doing so. Moreover, limiting bank reliance on wholesale funding always reduces systemic risk, but limiting the correlation between bank portfolios does not.

Keywords: Bank risk; Wholesale funding; Adverse selection; Multiple equilibria; Liquidity (search for similar items in EconPapers)
JEL-codes: G01 G21 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Bank Risk Within and Across Equilibria (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:48:y:2014:i:c:p:322-333

DOI: 10.1016/j.jbankfin.2014.05.012

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