Precision of Public Information Disclosures, Banks' Stability, and Welfare

Abstract

Consider a bank which chooses an asset portfolio and then, upon the public disclosure of the results of a review of its quality, raises funds by offering a repayment promise. We show that increasing the precision of information about the quality of the bank's assets lowers the cost of funding of a sound bank and encourages it to take risk. Maximum stability is reached in an opaque environment. Maximum surplus is reached in an opaque (transparent) environment when the social costs of bank failure are large (small). We examine how these conclusions change under alternative information and contractual conditions.