Rahma Faisal20617800ECON 496 – Assignment 3Summary: In the article, “Bank runs, liquidity, and deposit insurance”, Diamond and Dybvig present a model that illustrates the idea that customers are willing to pay a bank to manage the risk of not being completely sure how soon they might require their savings. The banks provide a feasible contract to depositors that allows them to prevent runs and provide optimal risk sharing by converting illiquid assets to offer liabilities with a smoother pattern of returns over time. Diamond and Dybvig then argue that if investment projects are long-term, the banks are more vulnerable to runs. Bank runs cause real economic problems because even healthy banks can fail, causing the recall of loans and the termination of productive investment. Therefore, a bank that has deposit insurance can provide liquidity insurance toa firm, which can prevent a liquidity crisis for a firm with short-term debt and limit the firm’s need to usebankruptcy to stop such crises.