How have the insights of three economists improved the ability of the financial system to survive severe crises and bank ‘walks’? Why is his work being rewarded now, nearly four decades after it was published? What lesson has India learned from his analysis?
How have the insights of three economists improved the ability of the financial system to survive severe crises and bank ‘walks’? Why is his work being rewarded now, nearly four decades after it was published? What lesson has India learned from his analysis?
the story So Far: On 10 October, The Royal Swedish Academy of Sciences unveiled the names of the winners of the Sveriges Riksbank Prize in Economic Sciences in memory of Alfred Nobel 2022. Award given jointly to three economists Among the final set of Nobel Prize winners to be announced this year: former US Federal Reserve Chairperson Ben S. Bernanke, a doctorate from the Massachusetts Institute of Technology; Douglas W. Diamond and Philip H. Diebwig, both have doctorates from Yale University. Diamond is a professor of finance at the University of Chicago’s Booth School of Business, while Diebwig is a banking and finance professor at the Olin Business School at Washington University in St.
Why was he selected for the award?
Bernanke, Diamond and Diebwig have been awarded the Nobel in Economics for their “research on banks and financial crises” conducted in the early 1980s, which constitutes the most modern banking research. His analysis, from nearly four decades ago, still informs efforts to emphasize the vitality of banks to keep the economy functioning smoothly, possible mechanisms to make them more robust during periods of crisis, and banks. How collapses can trigger a major financial crisis that could plague economies. Furthermore, his work went beyond the realm of mere theory and has had significant practical import in regulating financial markets and dealing with pre-emptive or crises. “The insights from the prize winners have improved our ability to survive both a serious crisis and a costly bailout,” said Torey Ellingson, chair of the Committee for the Prize in Economic Sciences.
What are the key insights gained from the work of these economists?
Bernanke, who headed the US Federal Reserve from 2006 to 2014, analyzed the worst modern economic crisis – the Great Depression of the 1930s that began in the US but continued to affect economies around the world for many years – In a 1983 article. He turned the traditional thinking of the time on its head, arguing that bank failures in the 1930s were not merely a result of recessions, but were, in fact, a contributing factor to the sluggish mark on economic activity. In addition to the obvious impact of the collapse of banks on the fortunes of their depositors, he argued that critical borrower profiles were lost when banks collapsed, thus hindering the ability to convert savings into investments that could revive the economy rapidly. Was. Previous economic historians had focused only on the failures of those banks as a factor that affected the economy as much as the contraction in the money supply. The Academy reported that Bernanke proved otherwise by ‘using historical documentary evidence and empirical data to highlight the importance of the credit channel for the spread of depression’.
Diamond and Diebwig, who completed their doctoral studies at Yale a year apart in the late 1970s, came together in 1983 to create theoretical models on the role of banks in an economy and what they called ‘runs’ on their deposits. ‘ makes it unsafe. While depositors want access to their savings kept with banks at any time, banks do not keep the money idle, invest and lend it to borrowers for a longer period. This term mismatch in the asset-liability profile of banks means that even rumors about the bank’s imminent collapse can become a self-fulfilling prophecy as all savers form a line to withdraw their money in a hurry, though banks can only use those savings. The part itself keeps it easy to meet regular withdrawals from a part of their depositor base. To meet the simultaneous withdrawal rush, a bank will be forced to sell its long-term investment, even if it is at a loss, in the hope that the deposit will stop bleeding before it runs out of cash in hand.
What framework did he propose?
The two economists not only came up with a logical framework for banks to understand this informally understood Achilles heel, but also provided solutions such as deposit insurance or the ‘lender of last resort’ policy, on which governments would respond to such failures. You can consider avoiding. “When depositors learn that the state has guaranteed their money, they don’t have to go to the bank as soon as rumors start about running the bank,” he explained. Most countries now have deposit insurance schemes, even though they hope and try to ensure that these risk covers are not exploited. The jury in charge of selecting Nobel said his work sparked a flurry of subsequent studies, yielding new fundamental insights on issues such as financial transition, wealth creation, financial dissemination and financial regulation.
In a 1984 paper, Diamond also demonstrated the banks’ ‘socially important function as intermediaries between many savers and borrowers’, as they were able to assess the latter’s creditworthiness and ‘ensure that loans were repaid. Used for good investment’ is in the best condition. This line of thought was also part of Bernanke’s analysis. “The theoretical and empirical findings of Bernanke, Diamond and Diebwig thus reinforce each other. Together they provide important insight into the beneficial role that banks play in the economy, but also how their weaknesses can lead to devastating financial crises. The committee deliberating on the economic sciences Nobel explained in a note.
Why has he been chosen now?
The world economy is passing through a new crisis, just as it was emerging from the bleeding induced by the COVID-19 pandemic. The International Monetary Fund (IMF) has warned that ‘the worst is yet to come’ and a recession remains in place for many countries, as wars in Europe stem from a ‘cost of living’ crisis triggered by food and energy concerns. The middle is spread. The Nobel jury’s choice may well be interpreted as a reminder to governments about lessons that will come in handy again as the current turmoil unfolds with fears about an imminent shock to the banking system. The findings of these economists have proved to be ‘extremely valuable to policymakers’, as evidenced by the actions taken by central banks and financial regulators in the face of two recent major crises – the Great Recession. [triggered by the global financial crisis between 2007-09 when shadow banks like Lehman Brothers collapsed] and the economic slowdown that resulted from the COVID-19 pandemic,’ it underlined.
Does it have any resonance for India?
Indian households as well as policy makers are all too familiar with the bank’s failures in the recent past, from the troubles of the privately run Global Trust Bank to the moratorium on withdrawals at several co-operative banks. Government and regulatory interventions to instill confidence in the banking system include higher deposit insurance cover, facilitating takeover of weak lenders and measures to curb bad loans. The Indian authorities seem to have accepted the key lessons learned from the work of the Nobel laureates. But as the government pursues privatization of banks with the aim of consolidating lenders to finance large investments and high growth, utmost regulatory and legislative vigilance is necessary to prevent any crash in the financial sector. As IMF Chief Economist Pierre-Olivier Gourinches warned, the risk of monetary, fiscal or fiscal policy manipulation has risen sharply amid high uncertainty and growing vulnerabilities.