Deposit claims, liquidity crises, and ‘bad bank’ policies
A joint work with Tianxi Wang (Essex). We present a General Equilibrium model that explains three important features of bank deposits. First, bank depositors can respond to unanticipated consumption needs by using their bank claims as a means of payments. Second, deposit claims give their holders the right to demand immediate repayment of their full face value. Third, precisely because banks grant demand rights to depositors, banks may experience equilibrium runs.
In our model, the negotiability of bank deposits insures depositors against unanticipated consumption needs; demandability is a response to asymmetric information problems and not to liquidity risk. Solvent banks can experience equilibrium liquidity crises in our model when depositors receive private signals of bank quality. We demonstrate that a ``bad bank'' policy can be the optimal response to such crises.