Theoretical model demonstrates a negative reversal rate where policy cuts contract bank lending, highlighting trade-offs between asset returns and run risk.
This article develops a parsimonious model that incorporates fundamental run risk into banks’ optimal decision-making. The model establishes the existence of a reversal rate in negative territory: below this threshold, further policy rate cuts cease to stimulate lending and instead reduce credit supply. This reversal arises from banks’ endogenous trade-off between the returns on credit assets and the liquidity costs associated with bank-run risk.
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Bai et al. (2026) studied this question.
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