Inequality and financial fragility

Abstract

I study how the distribution of wealth influences the government's response to a banking crisis and the fragility of the financial system. When the wealth distribution is unequal, the government's bailout policy during a systemic crisis will be shaped in part by distributional concerns. In particular, government guarantees of deposits will tend to be credible for relatively poor investors, but may not be credible for wealthier investors. As a result, wealthier investors will have a stronger incentive to panic and, in equilibrium, the institutions in which they invest are more likely to experience a run and receive a bailout. Thus, without political frictions and under a government that is both benevolent and utilitarian, bailouts will tend to benefit wealthy investors at the expense of the general public. Rising inequality can strengthen this pattern. In some cases, more progressive taxation reduces financial fragility and can even raise equilibrium welfare for all agents.

The Financial Inclusion Development and Its Impacts on Disposable Income

“…Only 3% take loans from a traditional financial sector, leading to a low level of investment (Demirgüç-Kunt & Singer, 2017). Consequently), due to the low level of investment, employment creation adversely leads to a rise in income inequality (Dabla-Norris et al, 2015; Mitkov, 2020). The income of the privileged class tends to increase while the income level of the low-income group remains low.…”

Optimal Deposit Insurance

“…The form of the policy that we consider (deposits are insured 100% up to a maximum, and 0% insured above that amount) matches well the policies implemented in many deposit insurance systems. The arguments in Mitkov (2020) can be adapted to show that this form of policy can be credible ex-post (for a given s) in our model under plausible circumstances, as follows. It is evident that deposit insurance policies can only be effective if they provide full coverage of deposits for at least some depositors.…”

“…Along this dimension, the recent work of Mitkov (2020) is the most closely related -see also Cooper and Kempf (2016). Building on the framework of Keister (2016), Mitkov (2020 studies the optimal ex-post government response (bailouts) to banking failures, relating inequality to financial fragility.…”

“…Along this dimension, the recent work of Mitkov (2020) is the most closely related -see also Cooper and Kempf (2016). Building on the framework of Keister (2016), Mitkov (2020 studies the optimal ex-post government response (bailouts) to banking failures, relating inequality to financial fragility. While his focus is different (ex-post bailouts), his work also features a non-trivial distribution of deposit sizes and a cost of public funds that determines the size of the intervention.…”

Unequal and Unstable: Income Inequality and Bank Risk

“…First, we contribute to the growing theoretical literature examining the effect of inequality on bank risk and financial instability more broadly. The underlying reasons for banking instability connected to income inequality can be traced to the political motivation to redistribute (Rajan, 2011), the wealth accumulation preferences of the wealthy (Kumhof et al, 2015), the redistribution through bailouts (Mitkov, 2020), and the saving glut of the rich (Mian et al, 2020b). We expand this literature by identifying (empirically and theoretically) another channel through which inequality can play a role in the banking system's stability.…”