The Nobel Prize for Economics rewards fundamental research on the “key” role of banks …

With the awarding of the Nobel Prize in Economics to Ben Bernanke, Douglas Diamond and Philip Dybvig, the jury awards “fundamental research” on the role of banks in times of calm but also in the turmoil of financial crises.

The works greeted on Monday date back to the 1980s: on the one hand, the work of the American duo Douglas Diamond and Philip Dybvig on the functioning of banks. On the other, former US Federal Reserve Chairman Ben Bernanke’s analysis of the Great Depression of the 1930s.

The “key” role of banks …

It was in 1983 that the “Diamond-Dybvig model” was born. The two researchers explain how the banks work “but also why the system is vulnerable and needs to be regulated,” explains the Swedish Academy of Sciences, responsible for awarding the prize.

It is “one of the most cited scientific papers in economics and finance,” according to Washington University in St. Louis, where Mr. Dybvig teaches.

The model focuses on the role of banks as intermediaries: receiving deposits from savers and distributing loans to households but above all to businesses, thus allowing the economy to function.

These bank investments in companies are a priori profitable in the long run and bring them income. Banks use the money entrusted to them by savers for this purpose, keeping only a part of it accessible in the event that some customers wish to withdraw their money.

Suddenly, if in a panic, too many customers want to withdraw their savings at the same time, this puts the banks in trouble. To the point of causing a profound crisis that affects “even fundamentally healthy banks”. The system is “vulnerable to rumors”, summarizes the academy.

… in financial crises

Bernanke’s work on the Great Economic Depression of the 1930s “can be seen as supporting the ideas developed” by Diamond and Dybvig, notes the Nobel committee.

Mr. Bernanke detailed “the importance of (bank) credit in the spread of depression” and demonstrated the impact of bank failures and the freezing of credit distribution, which aggravated the crisis.

Until then, the collapse of the banking system was seen primarily as a consequence, or at best, as a secondary cause of crisis.

The work of the three winners “reinforces each other” and sheds light on how the vulnerabilities of banks, essential to the functioning of the economy, can lead or even cause “devastating financial crises,” the jury explains.

Updated lighting

According to the academy, the work of the three winners proved to be “extremely valuable” in analyzing the last two major crises: the 2008 financial crisis, after the bankruptcy of the American bank Lehman Brothers, and the Covid-19 pandemic.

Their work had demonstrated the importance of good banking regulation as early as the 1980s. “Before the 2008 crisis, the sector was not perceived as particularly vulnerable in the world of finance and regulators”Douglas Diamond said during a press conference on Monday.

At that time, the “panic of the financial markets had a dramatic effect on the real economy” leading to a reduction in the supply of credit to households and businesses, explains the Nobel committee. On the contrary, during the Covid-19 pandemic, central banks “made sure to maintain credit to households and businesses”, thus limiting the damage. The three award-winning economists “have taught us that these policies are crucial ingredients in avoiding bank runs and preserving credit relationships,” adds the committee.

The 2008 crisis “and the improvements in regulation have made the system much less vulnerable today”, assures Diamond, who also underlines the good financial situation of the banks.

The problem, he adds, “is that vulnerabilities, panic episodes, upheavals and other crises can occur anywhere in the financial sector, not just at the level of commercial banks.”

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