Systemic risk, interbank relations and liquidity provision by the Central Bank
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In this paper, the authors model systemic risk in an interbank market and investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of a bank generates a chain reaction on the rest of the system.Abstract:
We model systemic risk in an interbank market. Banks face liquidity needs as consumers are uncertain about where they need to consume. Interbank credit lines allow to cope with these liquidity shocks while reducing the cost of maintaining reserves. However, the interbank market exposes the system to a coordination failure (gridlock equilibrium) even if all banks are solvent. When one bank is insolvent, the stability of the banking system is affected in various ways depending on the patterns of payments across locations. We investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of one bank generates a chain reaction on the rest of the system. We analyze the coordinating role of the Central Bank in preventing payments systemic repercussions and we examine the justification of the Too-big-to-fail-policy.read more
Citations
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References
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Bank Runs, Deposit Insurance, and Liquidity
TL;DR: The authors showed that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits, and showed that there are circumstances when government provision of deposit insurance can produce superior contracts.
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Monopolistic competition with outside goods
TL;DR: In this article, a model of spatial competition in which a second commodity is explicitly treated is presented, and it is shown that a zero-profit equilibrium with symmetrically located firms may exhibit rather strange properties.
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The Role of Demandable Debt in Structuring Optimal Banking Arrangements
TL;DR: Demandable-debt finance by banks warrants explanation because it entails costs of bank suspension, liquidation, and idle reserve holdings as mentioned in this paper, and an explanation is developed in which demandable debt provides incentive-compatible intermediation where the banker has comparative advantage in allocating investment funds but may act against the interests of uninformed depositors.
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Optimal Financial Crises
Franklin Allen,Douglas Gale +1 more
TL;DR: 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 as mentioned in this paper. But, 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.
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Banking panics and business cycles
TL;DR: The authors examined the seven panics during the U.S. National Banking Era (1863-1914) and examined depositor behavior under subsequent monetary regimes, concluding that panics are caused by the same relations governing consumer behavior during nonpanic times.