Under weak conditions, narrow banks are efficient if and only if financial intermediaries are redundant. Narrow banks are inefficient whenever some people consume positive amounts in both periods, since narrow banks provide liquidity by driving a wedge between private and social rates of return. In an example with a closed-form solution, the welfare cost of narrow banking can be large, but results are sensitive to the choice of parameters. On a positive note, if fractional reserve banks are subject to sunspot runs, narrow banking is superior for a sufficiently high probability of a run.
Discussant: Marius Zoican (VU University Amsterdam)
