Chapter 3.docx - Chapter 3 Bank Runs and Panics Outline...

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Chapter 3: Bank Runs and Panics Outline - Bank runs and Panics: Theories and Empirical Evidence - Diamond-Dybvig Model - Adverse information and bank run models Bank runs and Panics: Theories and Empirical Evidence - History of baking panics in the US o 6 bank panics before 1865 o 7 bank panics during the National Banking Era (1873-1914) o Great Depression (1929-1933) *Deposit insurance is a measure implemented in many countries to protect bank depositors, in full or in part, from losses caused by a bank’s inability to pay debts when due. Deposit insurance systems are one component of a financial system safety net that promotes financial stability. Before the Deposit Insurance legislation was implemented in 1933, bank panics were a recurrent feature of US banking. Three phases of that panic experience can be identified depending upon the type of regulatory framework in place: the pre-Civil era (1820-186 or the “antebellum years”0 the National Banking Era and the era of the Federal Reserve System. Federal regulation was absent in panics in 1819, 1837, 1857 and in the 1860 and 1861 panics. During the National Banking era, banking era, banking panics occurred in 1873, 1893 and 1907. After the Federal Reserve Act was passed in 1913, there were four full-scale banking panics, one in 1930, two in 1931 and one in 1933. *The 1913 Federal Reserve Act is U.S. legislation that created the current Federal Reserve System . Congress developed the Federal Reserve Act to establish economic stability in the United States by introducing a central bank to oversee monetary policy. - What is a Bank Run? Situation in which a lot of depositors (much more than expected..) decide to withdraw their money from their bank. Bank panics belong to a general class of financial shocks, which include panics in the stock market, the foreign exchange market and the acceleration of commercial bankruptcies. Its origin can be found in any sudden and unanticipated revision of expectation of deposit loss where there is an attempt, usually unsuccessful, to convert checking deposits into currency. - Two theories explain bank runs and panics o Bank run caused by information specific to a bank o Bank run as a random event (Diamond-Dybvig) - Gorton (1988) finds empirical evidence on the relationship between bank runs and economic cycles (this supports the specific information theory, more likely to happen in reality)
Diamond-Dybvig Model - Banks finance long term investments with funds from consumers with shorter term horizons… By pooling the liquidity risk of many consumers, the bank expands its capacity to invest in long term projects.

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