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Title: Banks Are Where The Liquidity Is

Author(s): Oliver Hart and Luigi Zingales

Publication Date: June 2014

Keyword(s): bailout, banking and Liquidity

Programme Area(s): Financial Economics

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.

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Bibliographic Reference

Hart, O and Zingales, L. 2014. 'Banks Are Where The Liquidity Is'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10017