The transparency of the banking system and the efficiency of information-based bank runs

Abstract

In this paper, we investigate the relationship between the transparency of banks and the fragility of the banking system. We show that information-based bank runs may be inefficient because the deposit contract designed to provide liquidity induces depositors to have excessive incentives to withdraw. An improvement in the transparency of a bank may reduce depositor welfare by increasing the chance of an inefficient contagious run on other banks. A deposit insurance system in which some depositors are fully insured and the others are partially insured can ameliorate this inefficiency. Under such a system, bank runs can serve as an efficient mechanism for disciplining banks. We also consider bank managers' control over the timing of information disclosure, and find that bank managers may use their influence to eliminate both inefficient and efficient bank runs. © 2006 Elsevier Inc. All rights reserved.