41 Pages Posted: 26 Jul 2014
Date Written: May 1, 2014
What is so special about banks that their demise often triggers government intervention? In this paper we show that, even ignoring interconnectedness issues, the failure of a bank causes a larger welfare loss than the failure of other institutions. The reason is that agents in need of liquidity tend to concentrate their holdings in banks. Thus, a shock to banks disproportionately affects the agents who need liquidity the most, reducing aggregate demand and the level of economic activity. The optimal fiscal response to such a shock is to help people, not banks, and the size of this response should be larger if a bank, rather than a similarly-sized nonfinancial firm, fails.
Keywords: liquidity, bailout, banking
JEL Classification: E41 G21, E51
Suggested Citation: Suggested Citation
Hart , Oliver and Zingales, Luigi, Banks Are Where the Liquidity Is (May 1, 2014). Chicago Booth Research Paper No. 14-27; Fama-Miller Working Paper. Available at SSRN: https://ssrn.com/abstract=2471277 or http://dx.doi.org/10.2139/ssrn.2471277
By Anat Admati