Working Paper: NBER ID: w25891
Authors: Gary B. Gorton
Abstract: Financial crises are bank runs. At root the problem is short-term debt (private money), which while an essential feature of market economies, is inherently vulnerable to runs in all its forms (not just demand deposits). Bank regulation aims at preventing bank runs. History shows two approaches to bank regulation: the use of high quality collateral to back banks’ short-term debt and government insurance for the short-term debt. Also, explicit or implicit limitations on entry into banking can create charter value (an intangible asset) that is lost if the bank fails. This can create an incentive for the bank to abide by the regulations and not take too much risk.
Keywords: bank regulation; financial crises; short-term debt; private money
JEL Codes: G2; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high-quality collateral backing short-term debt (G32) | decrease in the likelihood of financial crises (F65) |
| lack of effective regulation (G18) | increase in vulnerability of the banking system to crises (F65) |
| government insurance for short-term debt (H81) | stability of the banking system (G21) |
| presence of charter value (D46) | reduced risk-taking behavior (D91) |