Optimal Bank Regulation in the Presence of Credit and Run Risk

66 Pages Posted: 6 Oct 2017

See all articles by Anil K. Kashyap

Anil K. Kashyap

University of Chicago, Booth School of Business; National Bureau of Economic Research (NBER); Federal Reserve Bank of Chicago

Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: September 2017

Abstract

We modify the Diamond and Dybvig (1983) model of banking to jointly study various regulations in the presence of credit and run risk. Banks choose between liquid and illiquid assets on the asset side, and between deposits and equity on the liability side. The endogenously determined asset portfolio and capital structure interact to support credit extension, as well as to provide liquidity and risk-sharing services to the real economy. Our modifications create wedges in the asset and liability mix between the private equilibrium and a social planner’s equilibrium. Correcting these distortions requires the joint implementation of a capital and a liquidity regulation.

Keywords: Bank Runs, Credit Risk, Limited Liability, Regulation, Capital, Liquidity

JEL Classification: E44, G01, G21, G28

Suggested Citation

Kashyap, Anil K. and Tsomocos, Dimitrios P. and Vardoulakis, Alexandros, Optimal Bank Regulation in the Presence of Credit and Run Risk (September 2017). Saïd Business School WP 2017-17. Available at SSRN: https://ssrn.com/abstract=3048376 or http://dx.doi.org/10.2139/ssrn.3048376

Anil K. Kashyap (Contact Author)

University of Chicago, Booth School of Business ( email )

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Dimitrios P. Tsomocos

University of Oxford - Said Business School and St. Edmund Hall ( email )

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Alexandros Vardoulakis

Board of Governors of the Federal Reserve System ( email )

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United States

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