On the Instability of Banking and Other Financial Intermediation

51 Pages Posted: 15 May 2020

See all articles by Chao Gu

Chao Gu

University of Missouri - Columbia

Cyril Monnet

Bank for International Settlements (BIS)

Ed Nosal

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Randall Wright

University of Wisconsin - Madison - Department of Finance, Investment and Banking; Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Date Written: May 8, 2020

Abstract

Are financial intermediaries inherently unstable and, if so, why? To address this, we analyse whether model economies with financial intermediation are particularly prone to multiple, cyclic or stochastic equilibria. Several formalisations are considered: a dynamic version of Diamond-Dybvig banking incorporating reputational considerations; a model with fixed costs and delegated investment as in Diamond; one with bank liabilities serving as payment instruments similar to currency in Lagos-Wright; and one with intermediaries as dealers in decentralised asset markets, similar to Duffie et al. Although the economics and mathematics differ across specifications, in each case financial intermediation engenders instability in a precise sense.

Keywords: banking, financial intermediation, instability, volatility

JEL Classification: D02, E02, E44, G21

Suggested Citation

Gu, Chao and Monnet, Cyril and Nosal, Ed and Wright, Randall D., On the Instability of Banking and Other Financial Intermediation (May 8, 2020). BIS Working Paper No. 862, Available at SSRN: https://ssrn.com/abstract=3599252

Chao Gu (Contact Author)

University of Missouri - Columbia ( email )

Columbia, MO 65203
United States

Cyril Monnet

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Ed Nosal

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

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

Randall D. Wright

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-3860 (Phone)

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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