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Limited-Purpose Banking--Moving from "Trust Me" to "Show Me" Banking

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  • Christophe Chamley
  • Laurence J. Kotlikoff
  • Herakles Polemarchakis

Abstract

There are many alleged culprits for the bank runs of 2008 and their devastating economic fallout. But proprietary information and leverage top our list. Claims of proprietary information forced financial markets to operate on trust, while providing the perfect breeding ground for fraud. And leverage permitted creditors to run at the first whiff of fraud, leveling one financial giant after another. Limited Purpose Banking (LPB), presented here, is a financial reform that sharply curtails proprietary information and eliminates leverage and, thus, the possibility of financial collapse. LPB's adoption is supported by our simple model showing how fraud can destroy finance.

Suggested Citation

  • Christophe Chamley & Laurence J. Kotlikoff & Herakles Polemarchakis, 2012. "Limited-Purpose Banking--Moving from "Trust Me" to "Show Me" Banking," American Economic Review, American Economic Association, vol. 102(3), pages 113-119, May.
    • Handle: RePEc:aea:aecrev:v:102:y:2012:i:3:p:113-19
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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.102.3.113
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    References listed on IDEAS

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    1. Diamond, Peter A, 1982. "Aggregate Demand Management in Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 881-894, October.
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    Cited by:

    1. John H. Cochrane, 2014. "Toward a Run-free Financial System," Book Chapters, in: Martin Neil Baily & John B. Taylor (ed.), Across the Great Divide: New Perspectives on the Financial Crisis, chapter 10, Hoover Institution, Stanford University.
    2. Ahmed Mahdi Belouafi & Chaouki Bourakba & Karima Saci, 2015. "Islamic Finance and Financial Stability: A Review of the Literature التمويل الإسلامي والاستقرار المالي: مراجعة الأدبيات النظرية," Journal of King Abdulaziz University: Islamic Economics, King Abdulaziz University, Islamic Economics Institute., vol. 28(2), pages 3-42, July.
    3. Jungherr, Joachim, 2018. "Bank opacity and financial crises," Journal of Banking & Finance, Elsevier, vol. 97(C), pages 157-176.
    4. Timothy Jackson & Laurence J. Kotlikoff, 2021. "Banks as Potentially Crooked Secret Keepers," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(7), pages 1593-1628, October.
    5. Simas Kucinskas, 2015. "Liquidity Creation without Banks," Tinbergen Institute Discussion Papers 15-101/VI, Tinbergen Institute.
    6. Simas Kucinskas, 2015. "Liquidity creation without banks," DNB Working Papers 482, Netherlands Central Bank, Research Department.
    7. Butzbach, Olivier, 2014. "Trust in banks: a tentative conceptual framework," MPRA Paper 53587, University Library of Munich, Germany.

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