Optimal Banking Contracts and Financial Fragility

Huberto Ennis and Todd Keister

No 15-6, Working Paper from Federal Reserve Bank of Richmond

Abstract: We study a finite-depositor version of the Diamond-Dybvig model of financial intermediation in which the bank and all depositors observe withdrawals as they occur. We derive the constrained efficient allocation of resources in closed form and show that this allocation provides liquidity insurance to depositors. The contractual arrangement that decentralizes this allocation resembles a standard bank deposit in that it has a demand able debt-like structure. When withdrawals are unusually high, however,depositors who withdraw relatively late experience significant losses. This contractual arrangement can be fragile, admitting another equilibrium in which depositors run on the bank by withdrawing funds regardless of their liquidity needs.

JEL-codes: D82 G01 G21 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2015-07-20
New Economics Papers: this item is included in nep-ban and nep-cta
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Citations: View citations in EconPapers (7)

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Related works:
Journal Article: Optimal banking contracts and financial fragility (2016)
Working Paper: Optimal banking contracts and financial fragility (2012)
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