We modify the 1983 Diamond and Dybvig model so that banks offer liquidity services to depositors, raise equity funding, make risky loans, and invest in safe, liquid assets. Banks monitor borrowers to ensure that they repay loans and they are susceptible to depositor runs. We model the run decision by solving a novel global game. Relative to a social planner, banks opt for a more deposit-intensive capital structure, their assets may be more or less lending intensive, and the level of lending may be higher or lower. Correcting these three distortions requires a package of three regulations

This paper shows that liquidity regulation can trigger unintended credit booms in the presence of interbank market power. We consider a price setter and a continuum of price takers who trade reserves after the realization of idiosyncratic liquidity shocks. The price takers are endogenously less liquid and circumvent regulation by engaging in shadow banking, which leads to a reallocation of funding away from the more liquid price setter. This reallocation channel underlies the credit boom. Endogenous responses in bank liquidity ratios also affect the magnitude of the boom. We discuss extensions of the model and illustrate its quantitative performance with an application to China

Banks finance illiquid assets with demandable deposits, which discipline bankers but expose them to damaging runs. Authorities may not want to stand by and watch banks collapse. However, unconstrained direct bailouts undermine the disciplinary role of deposits. Moreover, competition forces banks to promise depositors more, increasing intervention and making the system worse off. By contrast, constrained central bank intervention to lower rates maintains private discipline, while offsetting contractual rigidity. It may still lead banks to make excessive liquidity promises. Anticipating this, central banks should raise rates in normal times to offset distortions from reducing rates in adverse times

Scholars differ on whether central bank intervention mitigates banking panics. In April 1929, a fruit fly infestation in Florida forced the U.S. government to quarantine fruit shipments from the state and destroy infested groves. In July, depositors panicked in Tampa and surrounding cities. The Federal Reserve Bank of Atlanta rushed currency to member banks beset by runs. We show that this intervention arrested the panic and estimate that bank failures would have been twice as high without the Federal Reserve’s intervention. Our results suggest that similar interventions may have reduced bank failures during the Great Depression

This paper examines the macroeconomic implications of sovereign risk in a model in which banks hold domestic government debt. News of a future sovereign default hampers financial intermediation. First, it tightens the funding constraints of banks, reducing their resources to finance firms (liquidity channel). Second, it generates a precautionary motive to deleverage (risk channel). I estimate the model using Italian data, finding that sovereign risk was recessionary and that the risk channel was sizable. I also use the model to measure the effects of subsidized long-term loans to banks. Precautionary motives at the height of the crisis imply that bank lending to firms responds little to these interventions

How do shocks to the banking sector travel through the corporate economy? Using a novel data set of interfirm sales, I show that suppliers exposed to a large and exogenous decline in bank financing pass this liquidity shock to their downstream customers. The spillover effect occurs through two channels: a reduction in trade credit offered and a reduction in the total supply of goods and services. After exposure to the spillover, downstream customers show a spike in credit risk and a reduction in employment. Overall, the paper highlights the importance of financial spillovers in explaining corporate sector outcomes

I study a model of the financial sector in which intermediation among debt-financed banks gives rise to an endogenous core-periphery network. Endogenous intermediation generates excessive systemic risk in the financial network. Financial institutions have incentives to capture intermediation spreads through strategic borrowing and lending decisions. By doing so, they tilt the division of surplus along an intermediation chain in their favor, while at the same time reducing aggregate surplus. The network is inefficient relative to a constrained-efficient benchmark, since banks that make risky investments “overconnect,” exposing themselves to excessive counterparty risk, while banks that mainly provide funding end up with too few connections

The appropriateness of many high-cost loan regulations depends on whether demand is driven by financial conditions ("misfortunes") or imperfect decisions ("mistakes"). Bank records from Iceland show borrowers have especially low liquidity just before getting a loan. Borrowers exhibit lower decision-making ability (DMA) in linked choice experiments: 45% of loan dollars go to the bottom 20% of the DMA distribution. Standard determinants of demand do not explain this relationship, which is also mirrored by the relationship between DMA and an unambiguous "mistake." Both "misfortune" and "mistake" thus appear to drive demand