To evaluate a bank’s resilience to financial stress, authorities often rely on private information from a peer institution, or counterparty. This reliance can be perilous, especially when assessing bailout options. Within a global games approach to bank runs, we study communication about a systemically important bank’s financial status between an informed counterparty of said bank and an uninformed authority. This communication is costless, non-binding, and unverifiable - and yet pivotal for the authority’s decision to bailout the bank. When information about the counterparty’s own liquidity needs is private, the counterparty may exaggerate the systemically important bank’s true need for support, but it may also withhold adverse information entirely. We show that the authority’s risks in assessing bailout options is (1) shaped by the strategic behavior of the informed counterparty, (2) dependent on knowledge of the counterparty’s own financial position, and (3) not necessarily continuous.
