There is a widespread view among macroeconomists that fluctuations in collateral are an important driver of credit booms and busts. This column distinguishes between ‘fundamental’ collateral – backed by expectations of future profits – and ‘bubbly’ collateral – backed by expectations of future credit. Markets are generically unable to provide the optimal amount of bubbly collateral, which creates a natural role for stabilisation policies. A lender of last resort with the ability to tax and subsidise credit can design a ‘leaning against the wind’ policy that replicates the ‘optimal’ bubble allocation.
Credit markets play an increasingly central role in modern economies. Within the OECD, for instance, domestic credit has risen from 100% of GDP in 1970 to approximately 160% of GDP in 2012 (as measured by the Bank for International Settlements). To be sure, this growth masks large variations across countries and over time, but there is a common feature to all these different country experiences that stands out. Credit has often alternated between ‘booms’ – periods of rapid growth – and ‘busts’ – periods of stagnation or significant decline.
Lessons for rescuing a SIFI: The Banque de France’s 1889 ‘lifeboat’
Pierre-Cyrille Hautcoeur, Angelo Riva, Eugene N. White02 July 2014
The key challenge for lenders of last resort is to ameliorate financial crises without encouraging excessive risk-taking. This column discusses the lessons from the Banque de France’s successful handling of the crisis of 1889. Recognising its systemic importance, the Banque provided an emergency loan to the insolvent Comptoir d’Escompte. Banks that shared responsibility for the crisis were forced to guarantee the losses, which were ultimately recouped by large fines – notably on the Comptoir’s board of directors. This appears to have reduced moral hazard – there were no financial crises in France for 25 years.
In the aftermath of the 2008 financial crisis, the Dodd-Frank Act of 2010 set out to limit the authority of the Federal Reserve to rescue insolvent financial institutions. Since 1932, Section 13(3) of the Federal Reserve Act had given the agency the power to lend to “any individual partnership, or corporation” in “unusual and exigent circumstances.” The 2010 Act now compels the Fed to consult with the Secretary of the Treasury before implementing a new lending program.
Incentives for avoiding delayed sovereign defaults
Ugo Panizza03 March 2013
Can we avoid delayed sovereign defaults? This column sketches out a flexible mechanism focused on the international lender, and competition between lenders, of last resort to ensure timeliness, transparency and larger sums than are currently available. The threat of competition should provide strong incentives for addressing imbalances in the governance of the main multilateral financial institutions
Christiane Nickel, Philipp Rother, Lilli Zimmermann
The international financial architecture needs a structured mechanism for dealing with sovereign defaults. The main problem with the status quo is that countries tend to sub-optimally delay necessary defaults, leading to substantial loss of value for debtors and creditors alike. Opponents and supporters of a structured mechanism for dealing with sovereign insolvency agree on the fact that this is a difficult endeavour.
Financial markets once again pushed Eurozone leaders to act. European Central Bank President Draghi recently promised to “do whatever it takes”. This column argues that Draghi made an implicit commitment to act as lender of last resort to Eurozone governments. This means optimism may be justified – if only because it suggests that the Eurozone has a great central banker who is both a serious economist and an astute politician.
On Thursday, the President of the European Central Bank, Mario Draghi, created a buzz by saying that the central bank “is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” This was enough to send the euro up and bond spreads down. But what was Draghi really saying? Very smart things, in fact, for the third time.
Draghi’s first installment
On 11 December 2011, barely one month after assuming his new responsibilities, and two weeks after having lowered the interest rate, Draghi said:
Procyclical bank risk-taking and the lender of last resort
Mark Mink31 August 2011
While central bank liquidity support is used on a large scale to combat the instability of the banking sector, this column argues that the prospect of receiving such support might well have been one of the causes of the instability. In particular, it shows that the provision of liquidity support stimulates banks to engage in various forms of risk-taking, and to do so in a procyclical way.
Since the outbreak of the global financial crisis in 2007, and particularly since the bankruptcy of Lehman brothers in September 2008, central banks in their roles as lenders of last resort have provided large-scale liquidity support not only to individual banks, but also to the banking sector as a whole. As President Trichet of the European Central Bank explained in November 2009:
The European Central Bank as a lender of last resort
Paul De Grauwe18 August 2011
With the Eurozone crisis casting doubt over the solvency of Spain and Italy, the ECB has once again intervened to provide liquidity in the government bond markets. This column asks the question: Is there such a role for the ECB as a lender of last resort?
In October 2008 the ECB discovered that there is more to central banking than price stability. This discovery occurred when it was forced to massively increase liquidity to save the banking system. The ECB did not hesitate to serve as lender of last resort to the banking system, despite fears of moral hazard, inflation, and the fiscal implications of its lending.
Global safety nets: The IMF as a swap clearing house
Eduardo Levy Yeyati, Tito Cordella18 April 2010
Is the international-lender-of-last-resort IMF agenda passé? This column argues that the IMF could act as a “central bank swap clearing house” – an independent entity that manages existing and enhanced central bank swap agreements in one liquidity network for eligible countries and stands ready to step in with traditional programmes if liquidity fails.
The emerging members of the G20 are promoting the debate on global safety nets as a key topic for the next G20 meeting. While an international lender of last resort is more appealing to these countries than conditionality-heavy IMF-led packages, its practical advantages depend critically on a number of aspects that are sometimes downplayed in the policy discussion. Is the international-lender-of-last-resort agenda overdue or simply passé? And would the IMF ever play an effective role on this front?
Who should decide on emergency liquidity assistance?
Jorge Ponce16 January 2010
What government agency should decide lender-of-last-resort policy? This column discusses the optimal allocation of decision-making authority, suggesting that the central bank decide emergency loans and the deposit insurance agency guarantee them. But providing greater liquidity assistance will also require punishment to deter moral hazard problems.
Many countries are revising their institutions to deal with troubled banks. In the UK, the Labour Party believes that the current arrangement – the Tripartite Standing Committee constituted by the HM Treasury, the Bank of England, and the Financial Services Authority – is the best framework for regulating and supervising financial institutions and wants to strengthen it.
A stability pact à la Maastricht for emerging markets
Alejandro Izquierdo, Ernesto Talvi12 December 2009
In spite of its global nature, the current crisis dealt a much smaller blow to emerging markets than its predecessor, the Russian/Long-Term Capital Management crisis of 1998. Although stronger fundamentals are part of the explanation, this column argues that the readiness of the international community to provide lender of last resort facilities played a key role and has major implications for the design of a new international financial architecture.
One of the most intriguing puzzles following the Lehman debacle is that, in spite of its global nature, the current crisis dealt a much smaller blow to emerging markets than its predecessor, the Russian/Long-Term Capital Management crisis of 1998 (Levy-Yeyati 2009, Walti 2009).
16 November 2009 - 1 January 1970, Auditorium, National Bank of Belgium, Brussels
SUERF/CEPS/BFF Conference followed by SUERF Annual Lecture 2009
<ul>Provision of liquidity and Lender of Last Resort operations: effectiveness, governance, cross-border and cross currency issues</ul>
<ul>Cross-border bank resolution</ul>
<ul>Deposit guarantee schemes: How to re-establish clients’ confidence</ul>
<ul>Limits of the "Lender of Last Resort", "Too big to fail" and "Too big to save" theses</ul>
<strong>Followed by the 2009 SUERF Annual Lecture to be delivered by Jaime Caruana, General Manager, Bank for International Settlements</strong>
Participation free of charge for members of SUERF, CEPS and the Belgian Financial Forum, <strong>non-members EUR 100</strong>