Banking Panics in the Context of Moral Hazard

Student: Shengeliia Aleksandr

Supervisor: Georgy Lukyanov

Faculty: International College of Economics and Finance

Educational Programme: Double degree programme in Economics of the NRU HSE and the University of London (Bachelor)

Year of Graduation: 2018

We build a model demonstrating that the likelihood of bank runs can have a disciplining effect, inducing the bank to exert monitoring effort and thereby mitigating the moral hazard problem. Consider the bank whose quality of loans depends on the effort exerted to monitor the quality of the projects. It is shown that, in the benchmark case where the deposits are fully insured by the state, the bank chooses to exert low effort, and accordingly low investment. On the other hand, in the case where the depositors observe the asset price and draw inference about the bank’s solvency, deciding to run on the bank once the asset price drops below some threshold, the bank gets motivated to monitor its investments.

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