Bank Runs, Deposit Insurance, and Liquidity pptx

Federal Reserve Bank of Minneapolis Quarterly Review

Vol. 24, No. 1, Winter 2000, pp. 14–23

Bank Runs, Deposit Insurance, and Liquidity

Douglas W. Diamond Philip H. Dybvig

Theodore O. Yntema Professor Boatmen’s Bancshares Professor

of Finance of Banking and Finance

Graduate School of Business John M. Olin School of Business

University of Chicago Washington University in St. Louis

Abstract

This article develops a model which shows that bank deposit contracts can provide

allocations superior to those of exchange markets, offering an explanation of how

banks subject to runs can attract deposits. Investors face privately observed risks

which lead to a demand for liquidity. Traditional demand deposit contracts which

provide liquidity have multiple equilibria, one of which is a bank run. Bank runs

in the model cause real economic damage, rather than simply reflecting other

problems. Contracts which can prevent runs are studied, and the analysis shows

that there are circumstances when government provision of deposit insurance can

produce superior contracts.

This article is reprinted from the Journal of Political Economy (June 1983, vol.

91, no. 3, pp. 401–19) with the permission of the University of Chicago Press.

The views expressed herein are those of the authors and not necessarily those of the Federal

Reserve Bank of Minneapolis or the Federal Reserve System.