Microeconomics of Banking

Professor: Lucie Ménager, Panthéon-Assas University

Objective: This course is an introduction to microeconomic theory of banking, which has developed since the 70’s mainly through a switch of emphasis from the modeling of risk to the modeling of imperfect information. This asymmetric information model is based on the assumption that different economic agents possess different pieces of information on relevant economic variables, and that they will use the information for their own profit. The model has been extremely useful in explaining the role of banks in the economy. It has also been useful in pointing out structural weaknesses of the banking sector that may justify government intervention--for example, exposure to runs and panics, the persistence of rationing in the credit market, and solvency problems. We will focus on why financial intermediaries exist, optimal contracting between lenders and borrowers, the equilibrium of the credit market, individual bank runs and systemic risk.

Outline:

1. Deposit contracts:

1.1 Bank runs (Diamond and Dybvig 1983)

1.2 Bank’s suspension of convertibility

2. Borrowing contracts:

2.1 Benchmark with symmetric information

2.2 Hidden outcome and audit (Townsend 1979, Gale and Hellwig 1985)

2.3 Hidden outcome and signalling (Bolton and Sharfstein 1990)

2.4 Hidden risk and collateral (Stiglitz and Weiss 1981)

2.5 Credit rationning (Williamson 1989)

Grading: Final exam at the end of the semester.

Bibliography:

• Microéconomie bancaire, F. Lobez and L. Vilanova, PUF
• Microeconomics of Banking, X. Freixas and J.-C. Rochet, MIT Press