Bank Runs, Liquidity and Credit Risk
Jukka P. Topi
Bank of Finland
Bank of Finland Research Discussion Paper No. 12/2008
In this paper, I develop a model that addresses the links between banks' liquidity outlook and their incentives to take credit risk. Assuming that both bank-specific liquidity shocks and credit losses are necessary to provoke bank runs, the model predicts that a bank's incentives to mitigate its credit risk by screening decrease if the probability of a bank-specific liquidity shock declines. This suggests that the benign liquidity outlook prevailing prior to the subprime crisis may have contributed to the lack of screening by banks that has been an important causal factor in the crisis.
Number of Pages in PDF File: 34
Keywords: liquidity, credit risk screening, bank runs
JEL Classification: G12, G21, G28working papers series
Date posted: May 20, 2008
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