Booms and Banking Crises

Abstract

Banking crises are rare events that break out in the midst of credit intensive booms and bring about particularly deep and long-lasting recessions. This paper attempts to explain these phenomena within a textbook DSGE model that features a non-trivial banking sector. In the model, banks are heterogeneous with respect to their intermediation skills, which gives rise to an interbank market. Moral hazard and asymmetric information in this market may lead to sudden interbank market freezes, banking crises, credit crunches and, ultimately, severe recessions. The model can potentially generate various types of banking crises. But the typical crisis breaks out endogenously, during a credit boom generated by a sequence of small positive supply shocks; it does not result from a large negative exogenous shock. Simulations of a calibrated version of the model indicate that it can mimic the main dynamic patterns of banking crises.

Keywords: Moral Hazard, Asymmetric Information, Lending Boom, Credit Crunch, Banking Crisis

JEL Classification: E32, E44, G01, G21