Optimal Banking Contracts and Financial Fragility

36 Pages Posted: 13 Aug 2015

See all articles by Huberto M. Ennis

Huberto M. Ennis

Federal Reserve Banks - Federal Reserve Bank of Richmond

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics

Date Written: 2015-07-20

Abstract

We study a finite-depositor version of the Diamond-Dybvig model of financial intermediation in which the bank and all depositors observe withdrawals as they occur. We derive the constrained efficient allocation of resources in closed form and show that this allocation provides liquidity insurance to depositors. The contractual arrangement that decentralizes this allocation resembles a standard bank deposit in that it has a demand able debt-like structure. When withdrawals are unusually high, however, depositors who withdraw relatively late experience significant losses. This contractual arrangement can be fragile, admitting another equilibrium in which depositors run on the bank by withdrawing funds regardless of their liquidity needs.

JEL Classification: D82, G01, G21

Suggested Citation

Ennis, Huberto M. and Keister, Todd, Optimal Banking Contracts and Financial Fragility (2015-07-20). FRB Richmond Working Paper No. 15-06. Available at SSRN: https://ssrn.com/abstract=2643142 or http://dx.doi.org/10.2139/ssrn.2643142

Huberto M. Ennis (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

HOME PAGE: http://econweb.rutgers.edu/tkeister

Register to save articles to
your library

Register

Paper statistics

Downloads
23
Abstract Views
366
PlumX Metrics