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Surviving the perfect storm: The role of the lender of last resort☆

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  • Alves, Nuno
  • Bonfim, Diana
  • Soares, Carla

Abstract

When banks are hit by a severe liquidity shock, central banks have a key role as lenders of last resort. Despite the well-established importance of this mechanism, it is challenging to analyze it empirically. We explore a unique setting in which banks suddenly lost access to market funding due to contagion fears at the onset of the euro area sovereign debt crisis. Using monthly data at the loan, bank, and firm level, we test the role of the central bank in a scenario of imminent collapse. We find that the liquidity obtained from the central bank played a key role in temporarily supporting the supply of credit to the real economy. However, the subdued loan demand, together with moral suasion and carry trade incentives, led to an increase in banks’ sovereign bond holdings using central bank funding.

Suggested Citation

  • Alves, Nuno & Bonfim, Diana & Soares, Carla, 2021. "Surviving the perfect storm: The role of the lender of last resort☆," Journal of Financial Intermediation, Elsevier, vol. 47(C).
  • Handle: RePEc:eee:jfinin:v:47:y:2021:i:c:s104295732100019x
    DOI: 10.1016/j.jfi.2021.100918
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    3. Diana Bonfim & Miguel A. Ferreira & Francisco Queiro & Sujiao (Emma) Zhao, 2022. "Sovereign-bank diabolic loop: The government procurement channel," Nova SBE Working Paper Series wp644, Universidade Nova de Lisboa, Nova School of Business and Economics.

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    More about this item

    Keywords

    Lender of last resort; Monetary policy; Credit channel; Financial crisis; Fixed rate full allotment;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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