Booms and banking crises

Working Papers No 545
February 2016

Banking crises are rare events that break out in the midst of credit intensive booms and bring about particularly deep and long-lasting recessions. This paper attempts to explain these phenomena within a textbook DSGE model that features a non-trivial banking sector. In the model, banks are heterogeneous with respect to their intermediation skills, which gives rise to an interbank market. Moral hazard and asymmetric information in this market may lead to sudden interbank market freezes, banking crises, credit crunches and severe recessions. Those "financial" recessions follow credit booms and are not triggered by large exogenous adverse shocks.

JEL classification: E32, E44, G01, G21

Keywords: moral hazard, asymmetric information, saving glut, lending boom, credit crunch, banking crisis