Efficient Financial Crises

We develop a theory of systemic financial crises. We obtain conditions under which a single bank optimally chooses a fragile capital structure that is subject bank runs. When depositors are unable to commit to long-term lending arrangements, they optimally finance the bank using short-term debt. With multiple banks, lack of depositors’ commitment leads depositors to invest via short-term debt in a financial system in which all banks make loans with correlated, volatile returns. The optimal financial system features occasional, costly systemic crises in which all banks are subject to ex post inefficient liquidations. In this sense, financial crises are efficient.