Optimal Bank Regulation in the Presence of Credit and Run Risk
Anil K. Kashyap,
Dimitrios Tsomocos and
No 2017-097, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US)
We modify the Diamond and Dybvig (1983) model of banking to jointly study various regulations in the presence of credit and run risk. Banks choose between liquid and illiquid assets on the asset side, and between deposits and equity on the liability side. The endogenously determined asset portfolio and capital structure interact to support credit extension, as well as to provide liquidity and risk-sharing services to the real economy. Our modifications create wedges in the asset and liability mix between the private equilibrium and a social planner's equilibrium. Correcting these distortions requires the joint implementation of a capital and a liquidity regulation.
Keywords: Bank runs; Capital; Credit risk; Limited liability; Liquidity; Regulation (search for similar items in EconPapers)
JEL-codes: E44 G01 G21 G28 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-rmg
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