The OrigINs of FINancial FragilITY

Objective

Banking crises are recurrent phenomena. They lead to large declines in economic activity and share two features: i) they are often triggered by runs, i.e., sudden withdrawals by depositors; and ii) they follow episodes of deregulation and/or lax supervision. The 2023 banking turmoil in the U.S. is no exception. After the relaxation of prudential rules in 2018, three midsized banks faced distress as a result of runs, leading to three of the largest failures in history. Motivated by these events, the proposal seeks to enhance our understanding of the occurrence of runs, the process leading to deregulation and the effectiveness of supervision. It is organized in three projects, one theoretical [T] and two empirical [E]. 1) Runs in modern banking [T]. The project builds a new framework to study why banks offer demandable debt, even if it creates run risk. Based on some stylized facts, it departs from the standard assumptions of competitive deposit market, risk averse investors and fully leveraged banks. The results will advance our knowledge on the role of capital for financial fragility, monetary policy transmission and central bank credibility. 2) The political economy of banking deregulation [E]. The link between crises and deregulation prompts the question of whether banks influence regulation. The project studies this issue in the context of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). Its goal is to better understand banks’ influence on politicians and the channels through which this influence is exerted. 3) Supervision with style: The impact of supervisors on bank behavior [E]. An important question is the extent to which the implementation of banking regulation through supervisory oversight has a role per se in fostering financial stability. Exploiting a unique and novel dataset, the project investigates whether and how supervisory intensity and individual supervisors’ characteristics matter for the effectiveness of supervision.