Transparency and bank runs

Abstract

In a banking model with imperfect information, I find that more precise information increases the economy’s vulnerability to bank runs. For low information quality, depositors cannot distinguish bad from good states based on their information and, absent liquidity shocks, have no incentives to withdraw early. As information quality increases and signals become more informative, depositors’ incentives to withdraw strengthen and run-proof contracts become costlier in risk-sharing terms: to prevent runs, the bank must offer less to early withdrawers. When information quality is high enough, the bank would rather forgo return and hold excess liquidity than choose a run-proof deposit contract.