DP2751 'Crony Capitalism', Bail Outs and Bank Runs

Author(s): Gianluca Femminis, Luigi Ruggerone
Publication Date: March 2001
Keyword(s): Bail Out, Bank Runs, Financial Crisis, International Lending
JEL(s): E61, F34
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2751

We present a simple model where bank runs are possible and we analyse the role of subsidization of future investment in this setting. We find that such a policy exacerbates the short-run liquidity problem for banks. Moreover, we highlight that a ‘shift in expectations’ about the keeping of the subsidization promises induces a bank run. We analyse the effects of a (partial) forced conversion of non liquidated deposits into banks equities, showing how a bank recapitalisation of this type may help solving the problem. In fact, the deposit to equity swap can make credible an ex post recovery of the banking system, thus preventing the shift in expectation from generating a self-fulfilling bank crisis. This commitment device may prove useful also in the case of ‘political uncertainty’.