ECON 330 Chapter Notes -Credit Risk, Excess Reserves, Interbank
12 Feb 2014
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The financial system is one of them most regulated sectors of the economy, and the most regulated financial institutions are the banks. They would only receive a fraction of their deposits. This made depositors reluctant to place their money in the bank because they couldn"t tell whether banks were unscrupulous or taking too much risk, making banks less viable. Another point is with regards to bank runs and the contagion effect. Lack of information about the quality of bank assets led to bank panics which have harmful effects to the economy. Depositors know that they will not be able to obtain their all their funds from the bank since banks operate on first come first serve basis. Depositors therefore have a strong incentive to show up at the bank first. Uncertainty about the health of the banking system can lead to runs on banks both good and bad.
