Managing Confidence in Emerging Market Bank Runs

30 Pages Posted: 15 Feb 2006

See all articles by Se-Jik Kim

Se-Jik Kim

International Monetary Fund (IMF)

Ashoka Mody

International Monetary Fund (IMF) - Research Department

Date Written: December 2004

Abstract

In a rational-expectations framework, we model depositors` confidence as a function of the probability of future bank bailouts. We analyze the effect of alternative bank bailout policies on depositors` confidence in an emerging market setting, where liquidity shortages of banks are revealed sequentially and governments cannot credibly commit to bailing out all potentially distressed banks. Our findings suggest that allowing early bank failures and using available liquidity for credible commitments to later bailouts can better boost confidence than early bailouts. This conclusion arises because with a high chance of liquidity shortage in the future, depositors may lose confidence and hence withdraw deposits even from potentially sound banks. Such a policy of late bailouts is likely to receive political support when a full bailout needs to be financed by taxation. The logic of late bailout remains valid even when banks may hide their distress or when closures of early distressed banks create contagion.

Keywords: Confidence, bank runs, bailout, sequential liquidity shortages

JEL Classification: G1, G2

Suggested Citation

Kim, Se-Jik and Mody, Ashoka, Managing Confidence in Emerging Market Bank Runs (December 2004). IMF Working Paper No. 04/235, Available at SSRN: https://ssrn.com/abstract=878995

Se-Jik Kim (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Ashoka Mody

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-9617 (Phone)
202-589-9617 (Fax)

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