Financial Institutions, Financial Contagion, and Financial Crises
33 Pages Posted: 1 Feb 2006
Date Written: May 2000
Financial crises are endogenized through corporate and interbank market institutions. Single-bank financing leads to a pooling equilibrium in the interbank market. With private information about one`s own solvency, the best illiquid banks will not borrow but rather will liquidate some premature assets. The withdrawals of the best banks from the interbank market may lead more solvent but illiquid banks to withdraw from the market, until the interbank market collapses. However, multi-bank financing leads to a separating equilibrium in the interbank market. Thus, bank runs are limited to illiquid and insolvent banks, and idiosyncratic shocks never trigger a contagious bank run.
Keywords: Financial institutions, financial contagion, financial crises, interbank market
JEL Classification: E44, E58, F32, G21, G33
Suggested Citation: Suggested Citation