Discussion of: “Money and Modern Discussion of: “Money and Modern Banking without Bank Runs” (D. Skeie)Banking without Bank Runs” (D. Skeie)

By: Giovanni Dell’Ariccia By: Giovanni Dell’Ariccia

(IMF and CEPR)(IMF and CEPR)

The paper shows that:

• Deposit insurance is not necessary to prevent liquidity runs in advanced economies.

• This contrasts with the classic Diamond-Dybvig multiple equilibria result.

• It is interesting from a normative point of view, since most deposit insurance schemes are in advanced economies.

• It is written as challenge to deposit insurance, but one could read it as in support (I do!)

Advanced economies need to meet several conditions to avoid runs

• Deposits are nominal and in domestic currency.

• Well functioning good markets.

• Bank liabilities cannot be converted to domestic assets held outside banking system.

• There is a frictionless inter-bank market.

• Free-floating currency (or closed economy).

Nominal deposits / smooth good markets• In Diamond-Dybvig deposits are real, non-contingent

claims on bank’s assets:

– Early withdrawals cannot be correctly priced at the margin.

– Quantities need to adjust → rationing for late withdrawers.

– Potential inefficiency (liquidity runs)

• In this paper deposits are nominal claims:

– Price adjustments on good markets make their real value contingent on mass of deposits withdrawn (De Nicolo’, JME).

– Early withdrawals are correctly priced.

– First-best allocation is achieved (no runs).

No currency and smooth inter-bank market

• All transactions are settled within the banking system (this where advance vs. developing countries may matter): → aggregate liquidity cannot be drained.→ inter-bank market is always “liquid enough”.

• In systems with more than one bank, informational asymmetries absent:→ banks always willing to lend to solvent but

illiquid institutions.

No role for foreign assets/goods

• Flexible exchange rate:

→ central bank will not drain liquidity by intervening.

→ domestic price of foreign goods adjusts with mass of withdrawals (as long as current account needs to balance).

So, to bring the runs back ...

• Make real value of deposits non-contingent on withdrawals.

• Get liquidity out of banking system.

• Stop inter-bank lending.

These may do (and some are actually out there):

• Fixed exchange rate regime.

• Sticky prices (?) – Inelastic import prices (?)

• Off-shore market for deposits.

• Storage of currency outside banking system.

• Frictions in the inter-bank market.

• Asymmetric information across banks.

Highly recommended read

• Very interesting and well-written paper.

• Carefully modeled. Could benefit from some further discussion of foreign channel.

• Should have more open interpretation of results: pro or contra deposit insurance?