Opacity: Insurance and Fragility
39 Pages Posted: 15 Jan 2020
Date Written: December 4, 2019
What are the effects of banks holding opaque, complex assets? Should regulators require bank assets to be more transparent? I study these questions in a model of financial intermediation where opacity determines how long the realized value of an asset remains unknown. By allowing a bank to sell assets before the realization is known, opacity provides insurance to the bank's depositors. However, higher opacity also increases depositors' incentives to join a bank run. In choosing the level of opacity, therefore, a bank faces a trade-off between providing insurance and increasing fragility. If depositors can accurately observe the level of opacity, banks will choose the socially efficient level. If depositors are unable to observe this choice, however, banks will have an incentive to become overly opaque and regulation to limit opacity can improve welfare.
Keywords: Opacity, Bank runs, Insurance, Banking regulation
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation