DP10265 Bank Liabilities Channel
The financial intermediation sector is important not only for channeling resources from agents in excess of funds to agents in need of funds (lending channel). By issuing liabilities it also creates financial assets held by other sectors of the economy for insurance purpose. When the intermediation sector creates less liabilities or their value falls, agents are less willing to engage in activities that are individually risky but desirable in aggregate (bank liabilities channel). The paper studies how financial crises driven by self-fulfilling expectations are transmitted, through this channel, to the real sector of the economy.