Banks’ Disclosure Choices in the Presence of Adverse Selection and Runs
42 Pages Posted: 16 Feb 2022 Last revised: 13 Feb 2023
Date Written: February 13, 2023
The transparency of banks about the prospects of their risky assets is an issue of great importance. In this paper, we present a theory of bank disclosure in which banks face both adverse selection and bank run/rollover risk. In our model, banks disclose information to reduce adverse selection in credit markets, but information disclosure can also trigger inefficient bank runs. We show that the level of disclosure chosen by banks and the associated probability of a run have parallel behaviors as a function of bank profitability. Moreover, the equilibrium level of bank disclosure exhibits an inverse-U shape against bank profitability. In addition, when bank runs are very costly, the disclosure level decreases and may become conservative. Conservatism makes bad news less informative, which may help prevent bank runs. Our model also provides several regulatory implications and is consistent with recent empirical findings.
Keywords: Adverse selection, Banks, Bayesian Persuasion, Disclosure, Runs
JEL Classification: G21, G28, M41, M48
Suggested Citation: Suggested Citation