In the context of banking theory, the 'Diamond-Dybvig' model explains:
A. Only the role of banks in solving adverse selection
B. Only the role of banks in monitoring firms
C. Why banks never face runs
D. The existence of banks as providers of liquidity insurance and the possibility of bank runs
Answer: Option D
Solution (By JKSSB Mock Tests)
The Diamond-Dybvig model shows that banks transform illiquid assets into liquid liabilities, providing liquidity insurance to depositors, but that this arrangement is vulnerable to self-fulfilling runs.
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