When Bad Things Happen to Good Banks: Contagious Bank Runs and Currency Crises

Abstract

The author develops a twin crisis model featuring multiple banks. At each bank, domestic and foreign depositors play a banking game. This game has a run and a no-run equilibrium. Bank failures drain reserves in addition to those drained when foreign agents convert domestic currency to foreign. The fixed exchange rate collapses if a threshold number of banks fail. Agents observe sunspots to aid their equilibrium selection. The numerical solution matches somewhat the Turkish financial sector prior to the crisis of 2001. The Turkish exchange rate appears to have exposed the financial system to a 10 per cent risk of collapse.Exchange rates, Financial institutions