Working Paper: CEPR ID: DP10017
Authors: Oliver Hart; Luigi Zingales
Abstract: What is so special about banks that their demise often triggers government intervention? In this paper we show that, even ignoring interconnectedness issues, the failure of a bank causes a larger welfare loss than the failure of other institutions. The reason is that agents in need of liquidity tend to concentrate their holdings in banks. Thus, a shock to banks disproportionately affects the agents who need liquidity the most, reducing aggregate demand and the level of economic activity. The optimal fiscal response to such a shock is to help people, not banks, and the size of this response should be larger if a bank, rather than a similarly-sized nonfinancial firm, fails.
Keywords: bailout; banking; liquidity
JEL Codes: E41; E51; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Failure of a bank (G21) | Larger welfare loss (D69) |
| Failure of a bank (G21) | Disproportionate impact on liquidity-constrained agents (F65) |
| Disproportionate impact on liquidity-constrained agents (F65) | Reduced aggregate demand (E20) |
| Reduced aggregate demand (E20) | Reduced economic activity (F69) |
| Losses incurred by senior tranche holders (G33) | More severe macroeconomic effects (E19) |
| Losses incurred by senior tranche holders (G33) | Reduced demand for services (J23) |
| Reduced demand for services (J23) | Cascading effects on overall economic activity (F69) |