Bank Fragility in Developing Economies

Banks supply liquidity to insure individuals against possible short-term consumption needs. The higher this level of illiquidity insurance the lower the investments in long run assets, and the higher the risk of a bank run generated by a real negative shock. If individuals are su ¢ ciently risk averse competitive banks tradeo ¤ liquidity insurance for portfolio risk. High growth expectations, typical of emerging economies, increases the optimal liquidity supply even when this increases the risk of bank run. On the contrary, deposit contracts o¤ered when economic performances are very uncertain, like in less developed economies, and where output uctuations are milder, like in developed economies, are not exposed to the risk of a real shock-induced bank run. Policies of providing bail-outs or deposit insurance are ex-ante Pareto e ¢ cient even if they always increase the risk of crisis. Some empirical evidence is provided