Contagious Bank Runs and Committed Liquidity Support
58 Pages Posted: 2 Feb 2021 Last revised: 10 Mar 2021
Date Written: December 30, 2020
In a crisis, regulators and private investors can find it difficult, if not impossible, to tell whether banks facing runs are insolvent or merely illiquid. We introduce such an information constraint into a global-games-based bank run model with multiple banks and aggregate uncertainties. The information constraint creates a vicious cycle between contagious bank runs and falling asset prices and limits the effectiveness of traditional emergency liquidity assistance programs. We explain how a regulator can set up committed liquidity support to contain contagion and stabilize asset prices even without information on banks' solvency, rationalizing some recent developments in policy practices.
Keywords: Committed liquidity support, Global games, Bank runs
JEL Classification: G01, G11, G21
Suggested Citation: Suggested Citation