Bank Risk Within and Across Equilibria

Author/Editor:

Itai Agur

Publication Date:

July 2, 2014

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

The global financial crisis highlighted that the financial system can be most vulnerable when it seems most stable. This paper models non-linear dynamics in banking. Small shocks can lead from an equilibrium with few bank defaults straight to a full freeze. The mechanism is based on amplification between adverse selection on banks' funding market and moral hazard in bank monitoring. Our results imply trade-offs between regulators' microprudential desire to shield individual weak banks and the macroprudential consequences of doing so. Moreover, limiting bank reliance on wholesale funding always reduces systemic risk, but limiting the correlation between bank portfolios does not.

Series:

Working Paper No. 2014/116

Subject:

Bank credit Bank deposits Banking Systemic risk

English

Publication Date:

July 2, 2014

ISBN/ISSN:

9781498306515/1018-5941

Stock No:

WPIEA2014116

Pages:

37

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