Working Paper: NBER ID: w20207
Authors: Oliver Hart; Luigi Zingales
Abstract: What is so special about banks that their demise often triggers government intervention? In this paper we develop a simple model where, 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. In the context of our model, 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: banks; liquidity; government intervention; welfare loss; financial crisis
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) | Direct loss of wealth for agents in need of liquidity (G33) |
| Failure of a bank (G21) | Indirect loss of liquidity (G33) |
| Indirect loss of liquidity (G33) | Reduces aggregate demand (E19) |
| Reduces aggregate demand (E19) | Reduces economic activity (F69) |
| Failure of a bank (G21) | Larger drop in GDP (F69) |
| Losses borne by debtholders (G33) | More significant impact on GDP (F69) |
| Losses borne by equity investors (G12) | Less significant impact on GDP (F69) |