Lender Of Last Resort Research Articles

Two views of the lender of last resort: Thornton and Bagehot

Résumé Henry Thornton et Walter Bagehot furent tous les deux partisans du rôle de prêteur en dernier ressort de la banque d’Angleterre, mais ils différaient sur les détails de sa mise en œuvre. Alors que Bagehot pensait que ce rôle était uniquement le produit de ses privilèges particuliers de monopole, Thornton le considérait comme l’aboutissement nécessaire du développement des activités bancaires ; alors que Bagehot localisait le rôle particulier des banques sur le marché du crédit, Thornton soulignait l’importance du passif du bilan du système bancaire ; alors que pour Bagehot la convertibilité en or était intangible, Thornton voulait la mettre en balance avec la nécessité de la stabilité monétaire.

Le “paper credit” et les multiples Mr Henry Thornton

Résumé Cet article met l’accent sur les critiques de Thornton à Adam Smith en liaison avec son analyse du prêteur en dernier ressort. Il suggère que trois Thornton apparaissent dans le Paper Credit . Le premier est l’anti-déflationniste soucieux de la première partie du livre. Le second est l’anti-inflationniste inquiet de la seconde partie. Le troisième correspond au banquier praticien qui avait compris l’architecture financière émergente qui débouchait sur l’éviction de la monnaie métallique par le "papier de crédit". On conjecture que l’existence des lois sur l’usure, entre autres, a pu empêcher Thornton d’examiner complètement la possibilité pour la Grande Bretagne de tendre vers un système sans espèces monnayées.

Lender of Last Resort and the Moral Hazard Problem

The paper considers a model in which limited liability causes an asset substitution problem for banks. The problem can at times become so severe that the current regulatory framework - based on a combination of effectively full deposit insurance, minimum capital requirements and prudential supervision - proves inadequate for mitigating the moral hazard. Against this background, consideration is given to the question of how, and at what cost, an increase in market discipline would improve incentives. Finally, the additional microeconomic incentive effects of lender of last resort (LOLR) arrangements in the various alternatives is discussed. In conclusion, it is argued that LOLR arrangements in which the terms of liquidity support depend on the bank's risk profile can be effective in improving the bank's incentives to make the desired risk choice in the first place.

The new currency boards and discretion: empirical evidence from Bulgaria

In recent years, a number of countries have introduced currency boards (CBs). Gaining in swing and popularity, this new generation CB preserves, to varying degrees, the Central Bank’s ability to function as the lender of last resort (LOLR) and to intervene in case of systemic risk. Recently, Central Bank flexibility has been preserved in different forms in Hong Kong, Argentina, Estonia, Lithuania and Bulgaria. Macro- and microeconomic implications of such departures from orthodox CBs have not been thoroughly studied yet. Theoretically, the introduction of this second-generation CB provides an opportunity for conducting discretionary monetary policy (though certainly not in its typical form). Some major, ensuing questions require answers. What are the new channels of monetary policy? Does an orthodox self-regulating (automatic) mechanism work with second-generation CBs? How are monetary disequilibria in the economy adjusted? We define an automatic mechanism as “the presence of a positive cointegration relationship between the overall balance of payments (BOPs) and the reserve money, and the absence of discretionary variables in the model.” The theoretical hypothesis is checked empirically based on Bulgarian data.

Original Sin, Balance Sheet Crises, and the Roles of International Lending

We present a stylized framework which encompasses a variety of sheet approaches to currency crises that have been suggested in the literature, and analyze their policy implications. The common theme is that currency and maturity mismatches in private sector balance sheets constrain the capacity of monetary and fiscal policies to deal with self-fulfilling capital account crises, and generate a role for international crisis lending. International lending could be used to back domestic last-resort lending to banks, or to loosen fiscal constraints. Provided they have a sound fiscal position in normal times, this can make countries immune to self-fulfilling crises.

'Original Sin', Balance Sheet Crises, and the Roles of International Lending

We present a stylized framework which encompasses a variety of sheet approaches to currency crises that have been suggested in the literature, and analyze their policy implications. The common theme is that currency and maturity mismatches in private sector balance sheets constrain the capacity of monetary and fiscal policies to deal with self-fulfilling capital account crises, and generate a role for international crisis lending. International lending could be used to back domestic last-resort lending to banks, or to loosen fiscal constraints. Provided they have a sound fiscal position in normal times, this can make countries immune to self-fulfilling crises.

Solvency Runs, Sunspot Runs, and International Bailouts

This paper introduces a model of international lender of last resort (ILLR) activity under asymmetric information. The ILLR is unable to distinguish between runs due to debtor insolvency and those which are the result of pure sunspots. Nevertheless, the ILLR can elicit the underlying state of nature from informed creditors by offering terms consistent with generating a separating equilibrium. Achieving the separating equilibrium requires that the ILLR lends to the debtor at sufficiently high rates. This adverse electing problem provides an alternative rationale for Bagehot's Principle of last-resort lending at high rates of interest to the moral hazard motivation commonly found in the literature.

Les déterminants et les acteurs du prêt international en dernier ressort pendant la période de l'étalon-or classique (1890-1914). Quelques enseignements pour l'avenir

Cet article analyse la fonction de prêt international en dernier ressort sous l'étalon-or classique, à travers deux dimensions : d'une part, les facteurs macro­économiques tenant aux interdépendances financières qui expliquent pourquoi la coopération émerge à partir d'intérêts communs et de complémentarités parfois fortuites ; d'autre part, les facteurs microéconomiques expliquant l'issue de la gestion des crises et le partage des responsabilités à travers les interactions des différents acteurs - État, banques centrales et banques commerciales. Ces analyses sont confrontées aux interrogations actuelles sur la mise en place de structures internationales de prêt en dernier ressort afin d'en tirer quelques enseignements.

Do Lender of Last Resort Policies Matter? The Effects of Reconstruction Finance Corporation Assistance to Banks During the Great Depression

The paper uses a unique set of Depression-era bank financial data in a two-step system of equations with instrumental variables to estimate the effectiveness of lender of last resort (LOLR) strategies in a survival model with self-selection bias. Decreasing RFC loan collateral requirements over 1932-1933 facilitate the analysis of a relationship between LOLR collateral and survival. The results suggest that the RFC's practice of subordinating depositors' and investors' interests through senior claims on banks' best assets may have caused banks to fail. Although recapitalization after March 1933 helped banks survive the Great Depression, recapitalization is not a typical LOLR strategy.

The International Lender of Last Resort: How Large is Large Enought?

This paper considers how an lender of last resort (LOLR) can prevent self-fulfilling banking and currency crises in emerging economies. We compare two different arrangements: one in which the LOLR injects liquidity into financial markets, and one in which its resources are used to back domestic banking safety nets. Both arrangements would require important changes in the global financial architecture: the first one would require a global central bank issuing an currency, while the second one would have to be operated by an international banking fund closely involved in the supervision of domestic banking systems.

Lender of Last Resort: What Have We Learned Since Bagehot?

The maintenance of financial stability is facilitated by well-designed “safety-net” arrangements aimed at limiting the risk of disruption in the financial system (crisis prevention) and the consequences of disruption if it arises (crisis management). An important element of crisis management is the lender of last resort (LOLR) function. This article reviews the main ideas on LOLR reflected in the academic literature, going back to Henry Thornton almost 200 years ago.

Optimal Bail Out Policy, Conditionality and Constructive Ambiguity

This paper addresses the issue of the optimal behaviour of the Lender of Last Resort (LOLR) in its microeconomic role regarding individual financial institutions in distress. It has been argued that the LOLR should not intervene at the microeconomic level and let any defaulting institution face the market discipline, as it will be confronted with the consequences of the risks it has taken. By considering a simple cost benefit analysis we show that this position may lack a sufficient foundation. We establish that, instead, uder reasonable assumptions, the optimal policy has to be conditional on the amount of uninsured debt issued by the defaulting bank. Yet in equilibrium, because the rescue policy is costly, the LOLR will not rescue all the banks that fulfill the uninsured debt requirement condition, but will follow a mixed strategy. This we interpret as the confirmation of the creative ambiguity principle, perfectly in line with the central bankers claim that it is efficient for them to have discretion in lending to individual institutions. Alternatively, in other cases, when the social cost of a bank's bankruptcy is high, it is optimal for the LOLR to bail out the insititution, and this gives support to the too big to fail policy.

Lender of Last Resort, an International Perspective

The name “lender of last resort” owes its origins to Sir Francis Barings, who in 1797 referred to the Bank of England as the “dernier resort” from which all banks could obtain liquidity in times of crisis.1The lender of last resort (“LOLR”) role of the central bank remains a major rationale for most central banks around the world, in both developed and developing countries.2While other central bank functions have recently come under fire (e.g. banking supervision), the importance of having the LOLR under the umbrella of the central bank is seldom contested.3It is the immediacy of the availability of central bank credit (the central bank being the ultimate supplier of high-powered money) that makes the LOLR particularly suitable to confront emergency situations.

The Lender of Last Resort

The Lender of Last Resort

Comment on Financial Crises, Payment System Problems, and Discount Window Lending

Discount Window The Federal Reserve's discount window is one of the four elements of the safety net under the banking and payments system in the United States. The other three are open market operations by the Fed, deposit insurance by the FDIC, and finality on interbank clearing settlements on Fedwire by the Fed. Although the discount window is often equated with the Fed's lender of last resort (LLR) operations, and Flannery at times appears to do so, it is more accurate to identify it as only one part of the LLR facility. The Fed can also provide macroliquidity to the system through open market operations. The relative importance of each of these two tools to a central bank depends on two factors: 1. The State of Financial Development in the Countty. If there is either no or an undeveloped financial market, the discount window is the only tool available to the central bank and is of great importance. The more developed the financial market is in a country, the more important are open market operations. Bagehot's often quoted statement that

The Reform of Federal Deposit Insurance

In the first essay, Calomiris argues that the most desirable means by which to achieve banking system stability is to permit unlimited branch banking combined with the type of privately administered formal deposit insurance programs of antebellum Indiana, Ohio, and Iowa. In the second essay, Barth and Bartholomew argue convincingly that the major culprit in the S&L crisis is the existing structure of the federal deposit insurance system. They take the view that the Financial Institutions Reform, Recovery and Enforcement Act was seriously flawed for its failure to adequately restructure the federal deposit insurance system. Brumbaugh and Litan express the view that due to the widespread use of accounting onventions to conceal balance sheet weaknesses, the number and assets of market-value insolvent banks cannot be known with any certainty. Kane argues that government deposit insurers have hidden or unacknowledged objectives and that these objectives conflict with the presumed long term goals of protecting depositors of modest means and preventing runs in a cost-effective manner. Romer and Weingast demonstrate how politicians benefited by keeping taxpayers uniformed about the thrift crisis and by establishing and enforcing a policy of forbearance. Chirinko and Guill quantitatively examine how macroeconomic shocks affect depository institutions. They argue that major problems can be encountered unless approaches to deposit-insurance reform and regulatory reform explicitly and carefully consider the impacts of such macroeconomic shocks on these institutions. Kaufman observes that, since 1974, the Federal Reserve has provided lender of last resort (LLR) assistance to prolong the life insolvent banks deemed too large to fail (TLTF). He argues that the LLR assistance in recent years has not saved most banks but has provided uninsured depositors time to flee without losses. It has frequently been argues that accounting techniques have played a significant part in the interaction of depository institutions and federal deposit insurance regulation. The last two papers in this book focus on the attributes of market-value accounting.

Lender of last resort: A contemporary perspective

This article re-examines the role of the central bank's lender of last resort (LLR) function in the current economic environment. It argues that the traditional role of protecting the money supply from collapse is no longer valid. LLR intervention is appropriate to offset temporary liquidity strains that are likely to depress asset prices and aggregate real income below their equilibrium levels. However, such support should be provided only rarely and through open market operations rather than the discount window.

The lender-of-last-resort function in the context of national and international financial crises

Die Funktion als Kreditgeber letzter Instanz im Zusammenhang mit nationalen und internationalen Finanzkrisen. - Die StabilitAt des Finanzsystems kann als ein offentliches Gut angesehen werden, das Interventionen der Regierung erfordert, sei es durch die Zentralbank als Kreditgeber letzter Instanz, sei es durch ein Zwangsversicherungs-system fur Einlagen. Selbst wenn die Zentralbank ihre volle “monetAre SouverAnitAt” uber die heimischen Banken ausuben kann, soweit es sich um Rettungsma\nahmen in heimischer WAhrung und um die Kredituberwachung zur EinschrAnkung von “moral hazard” handelt, so sind doch ihre Ma\nahmen als Kreditgeber letzter Instanz fur internationale Banken begrenzt, weil sie nicht immer uber ausreichende Devisenreserven verfugt. Besondere Aufmerksamkeit wird den Kriterien fur die ZahlungsunfAhigkeit eines Schuldnerlandes gewidmet, die sich wesentlich von denen eines Unternehmens unterscheiden. La fonction du «prEteur en dernier ressort» en contexte des crises financieres nationales et internationales. - La stabilite du systeme financier peut Etre consideree comme bien collectif rendant necessaire des interventions gouvernementales en terme de la fonction du «prEteur en dernier ressort» par la banque centrale ou d’un systeme d’assurance depositaire obligatoire. MEme bien qu’ une banque centrale puisse exercer son entiere «souverainete monetaire» sur les banques locales en ce qui concerne des operations de sauvetage en monnaie locale et la surveillance de credit pour reduire le «moral hazard» ses actions comme «prEteur en dernier ressort» pour des banques internationales sont limitees parce qu’elles ne disposent pas d’assez de reserves internationales. L’auteur tire l’attention particuliere aux criteres d’insolvabilite d’un pays debiteur qui sont essentiellement differents de ceux d’une entreprise. La funcioen de acreedor de Ultima instancia en el contexte de las crisis financieres nacionales e internationales. - La estabilidad del sistema financiero puede ser considerada como un bien pUblico que necesita intervenciones del gobierno atraves de la funcion de acreedor de Ultima instancia que cumple el banco central o de un sistema obligatorio de seguro de deposito. A pesar de que un banco central pueda ejercer su plena «soberania monetaria» sobre los bancos nacionales con respecta a operaciones de apoyo con moneda local y al control del credite a efectos de reducir el moral hazard, las posibilidades de actuar como acreedor de Ultima instancia son limitadas por no disponer de suficientes reservas internacionales. Especial atenciolan se le presta a los criterios de insolvencia que en el caso de un pais deudor difieren escencialmente de los que son aplicables a empresas.