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Who should act as lender of last resort? an incomplete contracts model

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  • Rafael Repullo

Abstract

This paper presents a model of a bank subject to liquidity shocks that require borrowing from a lender of last resort. Two government agencies may perform this function: a central bank and a deposit insurance corporation. The agencies share supervisory information, which provides a nonverifiable signal of the bank's financial condition, and use it to decide whether to support it. It is shown that the optimal institutional design involves the two agencies: the central bank dealing with small liquidity shocks, and the deposit insurance corporation with large shocks. Furthermore, except for very small shocks, they should lend at penalty rates.
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Suggested Citation

  • Rafael Repullo, 2000. "Who should act as lender of last resort? an incomplete contracts model," Proceedings, Federal Reserve Bank of Cleveland, pages 580-610.
  • Handle: RePEc:fip:fedcpr:y:2000:p:580-610
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    Keywords

    Lenders of last resort ; Bank liquidity;

    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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