http://econdse.org/wp-content/uploads/2012/04/GreenwoodSmith-JEDC97.pdf

Financial markets in development, and the development of financial markets

Empirical evidence suggests that banking panics are related to the business cycle and are not simply the result of "sunspots." Panics occur when depositors perceive that the returns on bank assets are going to be unusually low. We develop a simple model of this. In this setting, bank runs can be first-best efficient: they allow efficient risk sharing between early and late withdrawing depositors and they allow banks to hold efficient portfolios. However, if costly runs or markets for risky assets are introduced, central bank intervention of the right kind can lead to a Pareto improvement in welfare. FROM THE EARLIEST TIMES, banks have been plagued by the problem of bank runs in which many or all of the bank's depositors attempt to withdraw their funds simultaneously. Because banks issue liquid liabilities in the form of deposit contracts, but invest in illiquid assets in the form of loans, they are vulnerable to runs that can lead to closure and liquidation. A financial crisis or banking panic occurs when depositors at many or all of the banks in a region or a country attempt to withdraw their funds simultaneously. Prior to the twentieth century, banking panics occurred frequently in Europe and the United States. Panics were generally regarded as a bad thing and the development of central banks to eliminate panics and ensure financial stability has been an important feature of the history of financial systems. It has been a long and involved process. The first cerntral bank, the Bank of Sweden, was established more than 300 years ago. The Bank of England played an especially important role in the development of effective stabilization policies in the eighteenth and nineteenth centuries. By the end of the nineteenth century, banking panics had been eliminated in Europe. The last true panic in England was the Overend, Gurney & Company Crisis of 1866.

/pdf/optimal-financial-crises-5g52imrso0.pdf

Optimal Financial Crises

A complex financial system comprises both financial markets and financial intermediaries. We distinguish financial intermediaries according to whether they issue complete contingent contracts or incomplete contracts. Intermediaries such as banks that issue incomplete contracts, e.g., demand deposits, are subject to runs, but this does not imply a market failure. A sophisticated financial system a system with complete markets for aggregate risk and limited market participation is incentive-efficient, if the intermediaries issue complete contingent contracts, or else constrained-efficient, if they issue incomplete contracts. We argue that there may be a role for regulating liquidity provision in an economy in which markets for aggregate risks are incomplete.

https://papers.ssrn.com/sol3/Delivery.cfm/2451_27043.pdf?abstractid=1297793&mirid=1&type=2

Financial Intermediaries and Markets

A complex financial system comprises both financial markets and financial intermediaries. We distinguish financial intermediaries according to whether they issue complete contingent contracts or incomplete contracts. Intermediaries such as banks that issue incomplete contracts, e.g., demand deposits, are subject to runs, but this does not imply a market failure. A sophisticated financial system—a system with complete markets for aggregate risk and limited market participation—is incentive-efficient, if the intermediaries issue complete contingent contracts, or else constrained-efficient, if they issue incomplete contracts. We argue that there may be a role for regulating liquidity provision in an economy in which markets for aggregate risks are incomplete.

/pdf/financial-intermediaries-and-markets-22cwwma1nc.pdf

Inflation, financial markets and long-run real activity

Existing models of banking panics contain no role for monetary factors and fail to explain why some banking systems experienced panics while others did not. A monetary model is constructed, where seasonal variations in the demand for liquidity and credit play a critical role in generating banking panics. These panics occur when there are restrictions on the issue of currency in private banks, but they do not occur if banks are unrestricted. Empirical evidence from Canada and the United States for the period 1880-1910 is largely consistent with the predictions of the model.

/pdf/currency-elasticity-and-banking-panics-theory-and-evidence-4lmjuo9w7a.pdf

Bruce Champ

Papers

Currency Elasticity and Banking Panics: Theory and Evidence