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Banking crises and the lender of last resort: How crucial is the role of information?

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  • Naqvi, Hassan

Abstract

This article develops a model that studies how the presence of a lender of last resort (LOLR) affects the ex ante investment incentives of banks. We show that a perfectly informed LOLR induces a first-best outcome for small and medium sized banks but causes moral hazard in larger banks given the high contagion cost of their failure. On the other hand, an imperfectly informed LOLR causes allocational inefficiencies in the investment decisions of smaller banks but mitigates the moral hazard problem in larger banks due to the constructive ambiguity nature of bail-outs when the LOLR’s information set is noisy. Policy implications include stricter supervision for smaller banks, and “buffer” requirements complemented with liquidity provision at penalty rates for larger banks.

Suggested Citation

  • Naqvi, Hassan, 2015. "Banking crises and the lender of last resort: How crucial is the role of information?," Journal of Banking & Finance, Elsevier, vol. 54(C), pages 20-29.
  • Handle: RePEc:eee:jbfina:v:54:y:2015:i:c:p:20-29
    DOI: 10.1016/j.jbankfin.2015.01.004
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    Cited by:

    1. Acharya, Viral & Naqvi, Hassan, 2012. "The seeds of a crisis: A theory of bank liquidity and risk taking over the business cycle," Journal of Financial Economics, Elsevier, vol. 106(2), pages 349-366.
    2. Clemens Jobst & Kilian Rieder, 2016. "Principles, circumstances and constraints: the Nationalbank as lender of last resort from 1816 to 1931," Monetary Policy & the Economy, Oesterreichische Nationalbank (Austrian Central Bank), issue 3, pages 140-162.
    3. Hałaj, Grzegorz, 2006. "Contagion effect in banking system - measures based on randomised loss scenarios," MPRA Paper 525, University Library of Munich, Germany.
    4. Hassan Naqvi, 2014. "IMF Conditionality and the Intertemporal Allocation of Resources," International Review of Finance, International Review of Finance Ltd., vol. 14(2), pages 203-235, June.
    5. Cecile Bastidon & Philippe Gilles & Nicolas Huchet, 2008. "A Selective Bail-Out International Lending of Last Resort Model," Annals of Economics and Finance, Society for AEF, vol. 9(1), pages 103-114, May.
    6. Hryckiewicz, Aneta, 2014. "What do we know about the impact of government interventions in the banking sector? An assessment of various bailout programs on bank behavior," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 246-265.
    7. Bastidon, Cécile & Gilles, Philippe & Huchet, Nicolas, 2008. "The international lender of last resort and selective bail-out," Emerging Markets Review, Elsevier, vol. 9(2), pages 144-152, June.
    8. Moheeput, Ashwin, 2008. "Financial Systems, Micro-Systemic Risks and Central Bank Policy : An Analytical Taxonomy of the Literature," The Warwick Economics Research Paper Series (TWERPS) 856, University of Warwick, Department of Economics.

    More about this item

    Keywords

    Bank runs; Lender of last resort; Moral hazard;

    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; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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