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Pitfalls and Optimal Design of Emergency Liquidity Assistance

Author

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  • Schilling, Linda

Abstract

This paper studies why lender-of-last-resort support can fail to stop bank runs. In a nominal bank-run model with equity and multiple banks, I show that delayed Emergency Liquidity Assistance (ELA) shifts losses onto patient depositors and can trigger panic-driven withdrawals, even with sound assets and unlimited central-bank liquidity. The mechanism is a crisis-contingent, economy-wide inflation tax that insures early withdrawals while taxing those who stay, and redistributes resources across banks through the price level. The results highlight that ELA timing and fiscal design are critical for stability and can make regulatory interventions destabilizing rather than stabilizing.

Suggested Citation

  • Schilling, Linda, 2026. "Pitfalls and Optimal Design of Emergency Liquidity Assistance," MPRA Paper 128236, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:128236
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    File URL: https://mpra.ub.uni-muenchen.de/128236/1/MPRA_paper_128236.pdf
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    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G3 - Financial Economics - - Corporate Finance and Governance
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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