Interest on reserves, bank runs and investment decisions
Journal of Financial Regulation and Compliance
ISSN: 1358-1988
Article publication date: 10 May 2022
Issue publication date: 2 August 2022
Abstract
Purpose
This paper aims to study the effects of interest on reserves (IOR) on banks’ behavior in a theoretical framework.
Design/methodology/approach
This paper introduces IOR into both Cooper and Ross (1998) and Cooper and Ross (2002) and conducts quantitative analysis. It thoroughly examines the effects of IOR on banks’ resource allocation decisions under different assumptions.
Findings
In the model without deposit insurance, the results of this paper show that paying IOR facilitates the bank to use the run-proof contract. When the run-admitting contract is adopted, there is a set of conditions under which the bank is indifferent between holding illiquid asset and excess liquid reserves. In the model with deposit insurance, the results show that if the riskless illiquid investment is profitable and available, then paying IOR can hardly influence the bank's resource allocation. If the riskless illiquid investment is limited, then a certain level of IOR could fulfill some monetary targets.
Originality/value
Little research has combined IOR and model of bank runs. It helps to extend the theoretical analysis in this perspective.
Keywords
Acknowledgements
This paper is based on Chapter 2 of my PhD dissertation. This chapter was written under the guidance of Dr Joshua Hendrickson and Dr Jaevin Park. I sincerely appreciate their guidance. I also would like to thank Dr John Conlon, Dr Hailin Sang and anonymous reviewers for their useful comments.
Citation
Wang, Z. (2022), "Interest on reserves, bank runs and investment decisions", Journal of Financial Regulation and Compliance, Vol. 30 No. 4, pp. 393-411. https://doi.org/10.1108/JFRC-04-2021-0029
Publisher
:Emerald Publishing Limited
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