Bank Signaling, Risk of Runs, and the Informational Impact of Prudential Regulations

55 Pages Posted: 12 Aug 2021 Last revised: 26 Aug 2022

See all articles by Kebin Ma

Kebin Ma

University of Warwick - Finance Group

Tamas Vadasz

KU Leuven - Faculty of Economics and Business

Date Written: August 25, 2022

Abstract

Banks can take costly actions (such as higher capitalization, liquidity holding, and advanced risk management) to fend off runs. While such actions directly affect bank risks, they can also serve as signals of the banks' fundamentals. A separating equilibrium due to such signaling, however, would involve two types of inefficiency: strong banks choose excessively costly signals, whereas weak banks are particularly vulnerable to runs. We show that minimum regulatory requirements can maintain a pooling equilibrium and eliminate the inefficiencies associated with the separation. We support this novel rationale for prudential regulations with evidence from the US liquidity requirement.

Keywords: Prudential Regulations, Signaling, Bank Runs, Global Games

JEL Classification: G01, G11, G21

Suggested Citation

Ma, Kebin and Vadasz, Tamas, Bank Signaling, Risk of Runs, and the Informational Impact of Prudential Regulations (August 25, 2022). Available at SSRN: https://ssrn.com/abstract=3902600 or http://dx.doi.org/10.2139/ssrn.3902600

Kebin Ma (Contact Author)

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

HOME PAGE: http://www.kebinma.com

Tamas Vadasz

KU Leuven - Faculty of Economics and Business ( email )

Korte Nieuwstraat 33
2000 Antwerpen
Belgium

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