Empirical evidence suggests that banking panics are related to the business cycle
and are not simply the result of “sunspots.” Panics occur when depositors
perceive that the returns on bank assets are going to be unusually low. We develop
a simple model of this. In this setting, bank runs can be first-best efficient: they
allow efficient risk sharing between early and late withdrawing depositors and they
allow banks to hold efficient portfolios. However, if costly runs or markets for
risky assets are introduced, central bank intervention of the right kind can lead
to a Pareto improvement in welfare.