In Diamond and Dybvig the illiquidity of assets provides both the rationale for the existence of ban

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In Diamond and Dybvig the illiquidity of assets provides both the rationale for the existence of banks and for their vulnerability to runs. A bank run is caused by a shift in expectations. When normal volumes of withdrawals are known and not stochastic, suspension of convertibility of deposits will allow banks both to prevent bank runs and to provide optimal risk sharing by converting illiquid assets into liquid liabilities. In the more general case (with stochastic withdrawals), deposit insurance can rule out runs without reducing the ability of banks to transform assets. 1. Risk transformation approach This focuses on financial intermediaries’ ability to transform the risk characteristics of assets because they can overcome a market failure and resolve information asymmetry problem. Information asymmetry in credit markets arises because borrowers generally know more about

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