Sovereign Defaults, Bank Runs, and Contagion

Stephan Luck and Paul Schempp ()
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Paul Schempp: Max Planck Institute for Research on Collective Goods, Bonn

No 2014_15, Discussion Paper Series of the Max Planck Institute for Research on Collective Goods from Max Planck Institute for Research on Collective Goods

Abstract: We provide a model that unifies the notion of self-fulfilling banking crises and sovereign debt crises. In this model, a bank run can be contagious by triggering a sovereign default, and vice versa. A deposit insurance scheme can eliminate the adverse equilibrium only if the government can repay its debt and credibly insure deposits irrespective of the performance of the financial sector. Moreover, we analyze how banking crises and sovereign defaults can be contagious across countries. We give conditions under which the implementation of a banking union is effective and costless. Finally, we discuss the current proposals for a banking union in the euro area and argue that it should be extended by a supranational Deposit Guarantee Scheme.

Keywords: bank run; financial crisis; sovereign default; vicious cycle; financial contagion; banking union; deposit insurance (search for similar items in EconPapers)
JEL-codes: G21 G28 H63 H81 (search for similar items in EconPapers)
Date: 2014-09
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec, nep-ias and nep-opm
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