Optimal Bank Regulation In the Presence of Credit and Run-Risk

Anil Kashyap, Dimitrios Tsomocos and Alexandros P. Vardoulakis

No 26689, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We modify the Diamond and Dybvig (1983) model so that, besides offering liquidity services to depositors, banks also raise equity funding, make loans that are risky, and can invest in safe, liquid assets. The bank and its borrowers are subject to limited liability. When profitable, banks monitor borrowers to ensure that they repay loans. Depositors may choose to run based on conjectures about the available resources for people withdrawing early and beliefs about banks’ monitoring. We model the run decision by solving a novel global game. We find that banks opt for a more deposit-intensive capital structure than a social planner would choose. The privately chosen asset portfolio can be more or less lending-intensive, while the level of lending can also be higher or lower depending on a planner’s preferences between liquidity provision and credit extension. To correct these three distortions, a package of three regulations is warranted.

JEL-codes: E44 G01 G21 G28 (search for similar items in EconPapers)
Date: 2020-01
New Economics Papers: this item is included in nep-ban, nep-mac and nep-rmg
Note: CF ME
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Citations: View citations in EconPapers (13)

Published as Anil K Kashyap & Dimitrios P. Tsomocos & Alexandros P. Vardoulakis, 2024. "Optimal Bank Regulation in the Presence of Credit and Run Risk," Journal of Political Economy, vol 132(3), pages 772-823.

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Journal Article: Optimal Bank Regulation in the Presence of Credit and Run Risk (2024)
Working Paper: Optimal Bank Regulation in the Presence of Credit and Run Risk (2017)
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