of risk sharing functions. They should have a well-diversified portfolio of assets which would provide fixed returns over a time period to a depositor’s investment. They should also maintain an element of liquidity, so that if depositor wishes to liquidate his assets it can be done so on demand. The existence of these two functions means that a mismatch of assets and liabilities exists within the bank. It is widely documented that risk sharing contracts make banks very susceptible to ‘runs’."the solvency of one bank may be affected by the failure of another bank because of loss of confidence and large-scale withdrawals" usually as a result of "a mismatch between the date to maturity of assets and liabilities" (Stewart, 1996). These bank runs can have a drastic effect on the public as banks are where the vast majority of people carry out their financial transactions such as savings and mortgages. The public tends to have an inherent trust in the banks and therefore depositors have a reduced capacity for evaluating and monitoring their banks. Banks will not impose strict self-regulations unnecessarily. The danger of this situation is that banks might not provide services efficiently and therefore drag down the quality level of services in the industry. The need for public protection against these bank runs gives rise to the need for intervention to provide this protection: The"State guarantees to depositors and guarantees by central banks to act as lender of last resort may prevent sudden losses." (Stewart, 1996).Those who are against government intervention argue that it should be possible for banks to attain all levels of financing at any time in an efficient market, and that the existence of emergency financing will only ensure that banks will be negligent about their risk levels since they can rely on the central bank to aid any crises. In fact, banks hold forms of illiquid debt financing, so if a ‘run’ ...
