Inequality and financial fragility

Abstract

I study how the distribution of wealth influences the government’s response to systemic banking crises and shapes financial fragility. Distributional concerns tend to make full government guarantees of deposits credible for relatively poor individuals, but not for wealthier individuals. As a result, wealthier individuals have a stronger incentive to panic and, in equilibrium, the institutions in which they invest are endogenously more likely to experience runs and receive partial bailouts, even under utilitarian government. Moreover, the shape of the wealth distribution affects the level of financial fragility. Recognizing this fact may alter the government’s desire to redistribute wealth ex ante.