Bank fragility and growth expectations

Eugenio Proto*

*Corresponding author for this work

Research output: Contribution to journalArticle (Academic Journal)peer-review

Abstract

Banks supply liquidity to insure individuals against possible short-term consumption shocks. The higher this level of illiquidity insurance the lower the investments in long run assets, and the higher the risk of a bank run generated by a real negative shock. If individuals are sufficiently risk averse, competitive banks trade off liquidity insurance for portfolio risk. High growth expectations, typical of emerging economies, increase the optimal liquidity supply even when this increases the risk of a bank run. On the contrary, deposit contracts offered when economic performances are very uncertain (like in less developed economies), and where output fluctuations are milder (like in developed economies), are less exposed to the risk of a bank run. In this setting, a bail-out in case of crisis is ex-ante Pareto efficient even if it always increases the risk of crisis.

Original languageEnglish
Article number55
JournalBE Journal of Economic Analysis and Policy
Volume7
Issue number1
Publication statusPublished - 10 Dec 2007

Keywords

  • Bank run
  • Growth expectations
  • Illiquidity insurance
  • Portfolio risk

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