Bank Runs and Interventions with Wholesale Funding

Abstract

How does borrowing to refinance debts affect bank fragility and the effectiveness of policy responses? This paper answers this question by incorporating a wholesale market into the Diamond-Dybvig framework, and examining how the availability of external funds impacts the policymakers' trade-off between serving more depositors in the event of a run and preventing costly liquidation of investments. We show that, while wholesale borrowing in normal times can increase fragility in the absence of intervention, and decrease fragility in the presence of intervention, wholesale borrowing in times of crisis can decrease fragility in the absence of intervention, and increase fragility in the presence of intervention.

Keywords: Bank runs; Limited Commitment; Wholesale funding

JEL Classification: G21, G28, E58