Background on Bank Stability

Introduction

In recent years, the stability of banking systems has been a significant focus of economic research and policy-making. The 2008 financial crisis highlighted the fragility of banks and the potential for systemic failures. As a response, mechanisms like deposit insurance were bolstered to enhance depositor confidence and prevent bank runs. Despite these measures, bank runs remain a concern, as evidenced by several cases where insured banks still faced runs, such as Northern Rock in the UK and Washington Mutual in the US.

Recent studies, such as those by Kiss, Rodriguez-Lara, and Rosa-Garcia (2012), Peck and Shell (2012), and Andolfatto (2017), have explored various factors affecting bank runs, including deposit insurance levels, observability of depositor actions, and the design of deposit contracts. Kiss et al. (2012) found that higher levels of deposit insurance reduce the probability of bank runs when depositor decisions are not observable. However, observability of decisions complicates this dynamic, suggesting that optimal deposit insurance levels should consider the degree of observability. Peck and Shell (2012) illustrated that even optimal deposit contracts might allow for equilibrium bank runs under certain conditions, while Andolfatto (2017) emphasized the role of coordination among depositors and preventative measures.

Establishing Research Results in The Fedz

The Fedz, a turn-based game designed to simulate financial stability and bank operations, offers a unique environment to apply these research findings. The game can integrate the following insights:

1. Deposit Insurance Levels: Implement different levels of deposit insurance within the game to observe their impact on player behavior and bank stability. This can help simulate real-world scenarios where varying insurance levels influence depositor confidence and actions.

2. Observability of Actions: Create game scenarios where depositor actions are either visible or hidden to other players. This can test the hypothesis that observability acts as a partial substitute for deposit insurance, as indicated by Kiss et al. (2012).

3. Sequential Service Constraints: Introduce mechanisms that simulate the sequential service constraint, allowing players to experience how these constraints impact bank run equilibria, as discussed by Peck and Shell (2012).

4. Coordination Problems: Design game rounds that require players to coordinate their actions to prevent bank runs, reflecting the findings of Andolfatto (2017) on the importance of depositor coordination.