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Liquidity, Risk Taking, and the Lender of Last Resort

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Author Info
Rafael Repullo (CEMFI and CEPR)

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Abstract

This paper studies the strategic interaction between a bank whose deposits are randomly withdrawn and a lender of last resort (LLR) that bases its decision on supervisory information on the quality of the bank’s assets. The bank is subject to a capital requirement and chooses the liquidity buffer that it wants to hold and the risk of its loan portfolio. The equilibrium choice of risk is shown to be decreasing in the capital requirement and increasing in the interest rate charged by the LLR. Moreover, when the LLR does not charge penalty rates, the bank chooses the same level of risk and a smaller liquidity buffer than in the absence of an LLR. Thus, in contrast with the general view, the existence of an LLR does not increase the incentives to take risk, while penalty rates do.

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Publisher Info
Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 1 (2005)
Issue (Month): 2 (September)
Pages:
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Handle: RePEc:ijc:ijcjou:y:2005:q:3:a:2

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Find related papers by JEL classification:
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Rochet, Jean-Charles & Vives, Xavier, 2004. "Coordination Failures and the Lender of Last Resort : Was Bagehot Right After All?," IDEI Working Papers 294, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
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  2. Goodhart, Charles A E, 1999. "Myths about the Lender of Last Resort," International Finance, Blackwell Publishing, vol. 2(3), pages 339-60, November. [Downloadable!] (restricted)
  3. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December. [Downloadable!] (restricted)
    Other versions:
  4. Cordella, Tito & Yeyati, Eduardo Levy, 2003. "Bank bailouts: moral hazard vs. value effect," Journal of Financial Intermediation, Elsevier, vol. 12(4), pages 300-330, October. [Downloadable!] (restricted)
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  5. Prat, Andrea, 2003. "The Wrong Kind of Transparency," CEPR Discussion Papers 3859, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. Charles M. Kahn & João A. C. Santos, 2001. "Allocating bank regulatory powers: lender of last resort, deposit insurance and supervision," BIS Working Papers 102, Bank for International Settlements. [Downloadable!]
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  7. Charles Goodhart, 1999. "Myths About the Lender of Last Resort," FMG Special Papers sp120, Financial Markets Group. [Downloadable!] (restricted)
  8. Marvin Goodfriend & Robert G. King, 1988. "Financial deregulation, monetary policy, and central banking," Working Paper 88-01, Federal Reserve Bank of Richmond. [Downloadable!]
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  9. Repullo, Rafael & Suarez, Javier, 2004. "Loan pricing under Basel capital requirements," Journal of Financial Intermediation, Elsevier, vol. 13(4), pages 496-521, October. [Downloadable!] (restricted)
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  10. Benjamin A. Friedman & E. Gerald Corrigan & Irvine H. Sprague & Joseph A. Grundfest, 1991. "The Risks of Financial Crises," NBER Chapters, in: The Risk of Economic Crisis, pages 19-83 National Bureau of Economic Research, Inc. [Downloadable!]
  11. Marvin Goodfriend & Jeffrey M. Lacker, 1999. "Limited commitment and central bank lending," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-27. [Downloadable!]
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  12. Xavier Freixas & Curzio Giannini & Glenn Hoggarth & Farouk Soussa, 2000. "Lender of Last Resort: What Have We Learned Since Bagehot?," Journal of Financial Services Research, Springer, vol. 18(1), pages 63-84, October. [Downloadable!] (restricted)
  13. Patrick Bolton & Xavier Freixas, 2000. "Equity, Bonds, and Bank Debt: Capital Structure and Financial Market Equilibrium under Asymmetric Information," Journal of Political Economy, University of Chicago Press, vol. 108(2), pages 324-351, April. [Downloadable!] (restricted)
  14. Rafael Repullo, 2002. "Capital requirements, market power, and risk-taking in banking," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 150-163.
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  15. repec:fip:fedreq:y:1988:i:may:p:3-22:n:v.74no.3 is not listed on IDEAS
  16. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June. [Downloadable!] (restricted)
  17. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
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  18. Thomas F. Hellmann & Kevin C. Murdock & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March. [Downloadable!] (restricted)
  19. Rafael Repullo, 2000. "Who should act as lender of last resort? an incomplete contracts model," Proceedings, Federal Reserve Bank of Cleveland, pages 580-610.
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  20. Flannery, Mark J, 1996. "Financial Crises, Payment System Problems, and Discount Window Lending," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 804-24, November. [Downloadable!] (restricted)
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  21. Rafael Repullo, 2004. "Policies For Banking Crises: A Theoretical Framework," Working Papers wp2004_0418, CEMFI. [Downloadable!]
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Kharroubi, E. & Vidon E., 2008. "Liquidity, Moral Hazard and Inter-Bank Market Collapse," Documents de Travail 227, Banque de France. [Downloadable!]
  2. Claeys, Sophie, 2005. "Optimal regulatory design for the Central Bank of Russia," BOFIT Discussion Papers 7/2005, Bank of Finland, Institute for Economies in Transition. [Downloadable!]
  3. Javier Díaz-Giménez & Josep Pijoan-Mas, 2006. "Flat Tax Reforms In The U.S.: A Boon For The Income Poor," Working Papers wp2006_0611, CEMFI. [Downloadable!]
    Other versions:
  4. Acharya, Viral V & Gromb, Denis & Yorulmazer, Tanju, 2008. "Imperfect Competition in the Inter-Bank Market for Liquidity as a Rationale for Central Banking," CEPR Discussion Papers 6984, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  5. Jose Ceron & Javier Suarez, 2006. "Hot And Cold Housing Markets: International Evidence," Working Papers wp2006_0603, CEMFI. [Downloadable!]
    Other versions:
  6. Kleopatra Nikolaou, 2009. "Liquidity (risk) concepts - definitions and interactions," Working Paper Series 1008, European Central Bank. [Downloadable!]
  7. Aleix Calveras & Juan-José Ganuza & Gerard Llobet, 2005. "Regulation And Opportunism: How Much Activism Do We Need?," Working Papers wp2005_0508, CEMFI. [Downloadable!]
    Other versions:
  8. David G. Mayes & María J. Nieto & Larry Wall, 2008. "Multiple safety net regulators and agency problems in the EU: Is Prompt Corrective Action partly the solution?," Banco de España Working Papers 0819, Banco de España. [Downloadable!]
    Other versions:
  9. Beatriz Dominguez & Juan-José Ganuza & Gerard Llobet, 2006. "R&D In The Pharmaceutical Industry: A World Of Small Innovation," Working Papers wp2006_0601, CEMFI. [Downloadable!]
    Other versions:
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This page was last updated on 2009-11-17.

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