Strategic Complementarity

This paper identifies a novel bank-run externality: when depositors can shift funds across risky banks in a crisis, a large national bank perceived as safer may disproportionately raise the likelihood of runs among smaller regional banks. A minor shock can prompt a cascading chain reaction of deposit withdrawals among many regional banks, generating systemic vulnerabilities beyond traditional interbank-contagion channels. We extend global game models by allowing realistic deposit mobility across multiple risky banks, alongside the conventional risk-free option. Our framework captures the interaction between strategic complementarity in run/stay decisions among multiple substitutes—a dynamic that remains underexplored in the literature.

What quantity of reserves is sufficient to support effective monetary policy implementation and an efficient interbank payment system? To answer this question, I construct a model that links interbank intraday payment timing to monetary policy implementation. I show that a low reserve supply causes banks to delay payments to each other and strategically hoard reserves, which in turn disincentivizes banks from providing liquidity to short-term funding markets, driving up the spreads between overnight risk-free market rates and the central bank deposit rate and, impeding monetary policy implementation. As reserve balances get sufficiently low, even small reductions in reserves can have large impacts on these spreads, mirroring the repo-spike event observed in September 2019. The model also provides a counterfactual analysis of the sufficient reserve level that could have prevented the September 2019 repo spike, offering insights into the current discussions about the appropriate size of the Federal Reserve’s balance sheet.