Working Paper | 2010

A Behavioral Model of Demandable Deposits and Its Implications for Financial Regulation

by Julio J. Rotemberg

Abstract

A model is developed that rationalizes contracts that give depositors the right to obtain funds on demand even when depositors intend to use these funds for consumption in the future. This is explained by depositor overoptimism regarding their own ability to collect funds in a run. Capitalized institutions serving depositors with such beliefs emerge in equilibrium even if depositors and bank owners have the same preferences and the same investment opportunities. Various government regulations of these institutions, including minimum capital levels, requirements concerning the assets they may hold, deposit insurance, and compulsory clawbacks in bankruptcy, can raise the average ex post welfare of depositors.

Keywords: Banks and Banking; Insurance; Governing Rules, Regulations, and Reforms; Policy; Consumer Behavior; Financial Services Industry;

Citation:

Rotemberg, Julio J. "A Behavioral Model of Demandable Deposits and Its Implications for Financial Regulation." NBER Working Paper Series, No. 16620, December 2010.