Bank Heterogeneity and Financial Stability
We study how heterogeneity in banks’ asset holdings affects fragility. In the model, banks face a risk of bank runs and have to liquidate long-term assets in a common market to repay runners. Liquidation prices are depressed when many banks sell their assets at the same time. When banks are homogeneous, their selling behaviors are synchronized, and bank runs are exacerbated. We show that differentiating banks to some extent enhances the stability of all banks, even those whose asset performance ends up being weaker. Our analyses provide new insights about the regulation of banking sector’s architecture and the design of government support during crises.
Itay Goldstein has been retained by a law firm as an expert on a case involving a liquidity crisis and government intervention in a European bank. This case has not influenced the research in this paper, and the research in this paper has not influenced the case. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.