Diamond and Dybvig in developing economies and in a digital world

Abstract

The Nobel prize-winning article of Douglas Diamond and Philip Dybvig, entitled “Bank runs, deposit insurance, and liquidity” and published by the Journal of Political Economy in 1983, has spawned a large literature, including on emerging markets and developing economies. In a nod to Diamond and Dybvig, this paper reviews this subset of the literature, which has received relatively less attention than the rest despite the greater risk of banking crises in these economies; it then examines whether the seminal article remains relevant against the rapid digital transformation of financial systems today. Models that adopted their basic ideas helped drive home the importance of maintaining sound macroeconomic fundamentals and keeping confidence levels high in bank-centered economies. Similarly applying their framework to assess the impact of the current evolution of financial systems also reveals valuable insights, such as low risk from financial technology, for now, but possible shadow banks in those settings, and allows for generally better analysis, including pointing out possible blind spots when adopting new concepts, such as central-bank-issued digital currencies.