Financial Institutions, Financial Contagion, and Financial Crises

Haizhou Huang () and Chenggang Xu

No 316, William Davidson Institute Working Papers Series from William Davidson Institute at the University of Michigan

Abstract: Financial crises are endogenized through corporate and interbank market institutions. Financial crises can emanate from financial institutions which determine the nature of equilibrium in the interbank market. Single-bank financing leads to a pooling equilibrium whereby all illiquid banks are treated in the same manner in the interbank market. With private information about one's own solvency, the best illiquid banks will not borrow but rather will liquidate some premature assets. The withdrawals of the best banks from the interbank market will generate negative externalities in the market. Consequently, the quality of the interbank market will decline - which will make the more solvent but illiquid banks withdraw from the market - and thus the quality of the market will be further deteriorated and more banks will withdraw from the market, until interbank market collapses. However, multi-bank financing leads to a separating equilibrium whereby solvent and insolvent banks are distinguishable in the interbank market. As a result, bank runs are limited to illiquid and insolvent banks, and idiosyncratic shocks never trigger a bank run contagion.

Pages: pages
Date: 2000-03-01
New Economics Papers: this item is included in nep-fmk and nep-ifn
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Related works:
Working Paper: Financial Institutions, Financial Contagion, and Financial Crises (2000)
Working Paper: Financial Institutions, Financial Contagion, and Financial Crises (2000)
Working Paper: Financial Institutions, Financial Contagion, and Financial Crises (1999)
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