Research Discussion Papers, Bank of Finland
Bank runs, liquidity and credit risk
Abstract: In this paper, I develop a model that addresses the links
between banks’ liquidity outlook and their incentives to take credit risk.
Assuming that both bank-specific liquidity shocks and credit losses are
necessary to provoke bank runs, the model predicts that a bank’s incentives
to mitigate its credit risk by screening decrease if the probability of a
bank-specific liquidity shock declines. This suggests that the benign
liquidity outlook prevailing prior to the subprime crisis may have
contributed to the lack of screening by banks that has been an important
causal factor in the crisis.
Keywords: liquidity; credit risk screening; bank runs; (follow links to similar papers)
JEL-Codes: G12; G21; G28; (follow links to similar papers)
31 pages, May 14, 2008
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