We examine banking regulation in a macroeconomic model of bank runs. We construct a general equilibrium model where banks may default because of fundamental or self-fulfilling runs. With only fundamental defaults, we show that the competitive equilibrium is constrained efficient. However, when banks are vulnerable to runs, banks’ leverage decisions are not ex-ante optimal: individual banks do not internalize that higher leverage makes other banks more vulnerable. The theory calls for introducing minimum capital requirements, even in the absence of bailouts.
Authors
- Acknowledgements & Disclosure
- The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis, the Federal Reserve System, or the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w32341
- Published in
- United States of America