Money and Modern Bank Runs

Bank runs in the literature following Diamond and Dybvig (1983) take the form of withdrawals of demand deposits payable in real goods, which deplete a fixed reserve of goods in the banking system. This paper examines modern bank runs, in which withdrawals typically take the form of electronic payments by large depositors. These transfers shift balances among banks, with no analog of a depletion of a scarce reserve from the banking system.

I show that with nominal demand deposits payable in money using modern payment systems, panic runs do not occur if there is efficient lending among banks. Aggregate shocks to investment returns also do not cause bank runs because nominal deposits allow real consumption to adjust efficiently with prices. Additionally, currency withdrawals do not cause traditional depositor runs unless all banks are subject to panics.

However, if interbank lending breaks down, bank runs occur due to a coordination failure in which banks do not lend to a bank in need. This can lead to price deflation and contagion to other banks. Policy conclusions--such as deposit insurance and suspension of convertibility that solve depositor-based runs as in Diamond-Dybvig--are neither necessary nor sufficient to prevent interbank-based banking crises.

Rather, central bank intervention as lender of last resort is necessary.