Transparency in the Financial System: Rollover Risk and Crises

Abstract

The paper presents a theory of optimal transparency when financial institutions are exposed to rollover risk. Transparency enhances the stability of the financial system during crises but has destabilizing effects in normal economic times. Thus, the regulator optimally increases transparency during crises. Under this policy, however, increasing transparency signals a deterioration of economic fundamentals, which gives regulators ex-post incentives to withhold information. The theory relates optimal transparency to financial institutions' incentives to diversify their risk and hold liquidity. In particular, the optimal policy reduces the net benefit of diversification and generates an equilibrium level of liquidity that is inefficiently low.

Keywords: transparency, banking, rollover risk, crises

JEL Classification: G21, G24, G01