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Bank of Finland Research Discussion Papers, Bank of Finland

No 24/2005:
The transparency of the banking industry and the efficiency of information-based bank runs

Yehning Chen and Iftekhar Hasan ()

Abstract: In this paper, we investigate the relationship between the transparency of banks and the fragility of the banking system. We show that information-based bank runs may be inefficient because the deposit con-tract designed to provide liquidity induces depositors to have excessive incentives to withdraw. An im-provement in transparency of a bank may reduce depositor welfare through increasing the chance of an inefficient contagious bank run on other banks. A deposit insurance system in which some depositors are fully insured and the others are partially insured can ameliorate this inefficiency. Under such a system, bank runs can serve as an efficient mechanism for disciplining banks. We also consider bank managersí control over the timing of information disclosure, and find that they may lack the incentive to reveal in-formation about their banks.

Keywords: bank run; contagion; transparency; market discipline; deposit insurance; (follow links to similar papers)

JEL-Codes: G21; G28; (follow links to similar papers)

44 pages, October 11, 2005

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