Banks Are Where the Liquidity Is

41 Pages Posted: 26 Jul 2014  

Oliver Hart

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Luigi Zingales

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: May 1, 2014

Abstract

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

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

Oliver D. Hart

Harvard University - Department of Economics ( email )

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Cambridge, MA 02138
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National Bureau of Economic Research (NBER) ( email )

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Luigi Zingales (Contact Author)

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
United States
773-702-3196 (Phone)
773-834-2081 (Fax)

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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London, EC1V 3PZ
United Kingdom

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