A Model of Systemic Bank Runs

Abstract

We develop a tractable model of systemic bank runs. The market-based banking system features a two-layer structure: banks with heterogeneous fundamentals face potential runs by their creditors while they trade short-term funding in the asset (interbank) market in response to creditor withdrawals. The possibility of a run on a particular bank depends on its assets' interim liquidation value, and this value depends endogenously in turn on the status of other banks in the asset market. The within-bank coordination problem among creditors and the cross-bank price externality feed into each other. A small shock can be amplified into a systemic crisis.