I revisit the Diamond-Dybvig model of liquidity insurance in the presence of hidden trades. The key result is that in this environment deposit-taking banks are not necessary for the efficient provision of liquidity. Mutual funds are constrained efficient when supplemented with the same government liquidity regulation that is required to make a banking system constrained efficient. However, whereas banks are potentially subject to costly panics, mutual funds are not run-prone and hence superior from a welfare perspective if runs happen with a non-zero probability.
# 15-101/VI (2015-08-20)
- Simas Kucinskas, VU University Amsterdam, the Netherlands
- Liquidity creation, liquidity insurance, hidden trades, bank runs, mutual funds, narrow banking, financial stability
- JEL codes:
- D91, E61, G21, G23, G28