Discuss research on the role of banks and other financial institutions in the intermediation of funds between lenders and borrowers.

What will be an ideal response?

ANSWER:

Work by Doug Diamond and Philip Dybvig in the 1980s had clarified the nature of bank runs : liquid assets and liquid liabilities created a risk of runs even for solvent banks. The problem could only be avoided by the provision of liquidity by the central bank if and when needed. Work by Bengt Holmström and Jean Tirole had shown that liquidity issues were endemic to a modern economy. Andrei Shleifer discussed the limits of arbitrage. Behavioral economists had pointed to the way in which individuals differ from the rational individual model typically used in economics, and had drawn implications for financial markets.