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Banking Crises and the Lender of Last Resort: How crucial is the role of information?

  • Hassan Naqvi

    (NUS Business School, & Financial Markets Group, LSE)

This article develops a model of bank runs and crises and analyses how the presence of a lender of last resort (LOLR) affects the solvency of the banking system. We obtain a one to one mapping from the depositors' equilibrium strategy to an optimal contract prevailing in the economy. The study finds that the difference between a perfectly informed and an imperfectly informed LOLR can be crucial. Our results indicate that a perfectly informed LOLR is a Pareto improvement. However, if the supervisory process of the LOLR is subject to noise, then the gains from ex post efficiency may be outweighed by ex ante inefficiency induced by moral hazard which is conducive to lower lending rates in the economy.

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File URL: http://128.118.178.162/eps/fin/papers/0410/0410009.pdf
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Paper provided by EconWPA in its series Finance with number 0410009.

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Length: 40 pages
Date of creation: 14 Oct 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0410009
Note: Type of Document - pdf; pages: 40
Contact details of provider: Web page: http://128.118.178.162

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  1. Jean-Charles Rochet & Xavier Vives, 2004. "Coordination Failures and the Lender of Last Resort: Was Bagehot Right After All?," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 1116-1147, December.
  2. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-97, June.
  3. Stephen Morris & Hyun Song Shin, 2001. "Coordination risk and the price of debt," LSE Research Online Documents on Economics 25046, London School of Economics and Political Science, LSE Library.
  4. repec:ner:tilbur:urn:nbn:nl:ui:12-154416 is not listed on IDEAS
  5. Goodhart, Charles A.E. & Huang, Haizhou, 2005. "The lender of last resort," Journal of Banking & Finance, Elsevier, vol. 29(5), pages 1059-1082, May.
  6. Amil Dasgupta, 2002. "Financial Contagion through Capital Connections: A Model of the Origin and Spread of Bank Panics," FMG Discussion Papers dp436, Financial Markets Group.
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  8. Bernanke, Ben & Gertler, Mark, 1990. "Financial Fragility and Economic Performance," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 87-114, February.
  9. Ben S. Bernanke, 1983. "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression," NBER Working Papers 1054, National Bureau of Economic Research, Inc.
  10. Carlsson, Hans & van Damme, Eric, 1993. "Global Games and Equilibrium Selection," Econometrica, Econometric Society, vol. 61(5), pages 989-1018, September.
  11. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  12. Stephen Morris & Hyun Song Shin, 2000. "Global Games: Theory and Applications," Cowles Foundation Discussion Papers 1275, Cowles Foundation for Research in Economics, Yale University.
  13. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  14. Charles Goodhart, 2000. "The Organisational Structure of Banking Supervision," FMG Special Papers sp127, Financial Markets Group.
  15. Charles W. Calomiris, 1998. "The IMF's Imprudent Role As Lender of Last Resort," Cato Journal, Cato Journal, Cato Institute, vol. 17(3), pages 275-294, Winter.
  16. Amil Dasgupta, 2002. "Financial contagion through capital connections: a model of the origin and spread of bank panics," LSE Research Online Documents on Economics 24956, London School of Economics and Political Science, LSE Library.
  17. Hyun Shin, 2001. "Coordination Risk and the Price of Debt," Economics Series Working Papers 1999-W25, University of Oxford, Department of Economics.
  18. Mark J. Flannery, 1996. "Financial crises, payment system problems, and discount window lending," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 804-831.
  19. Walter B. Wriston, 1998. "Dumb Networks and Smart Capital," Cato Journal, Cato Journal, Cato Institute, vol. 17(3), Winter.
  20. Stephen Morris & Hyun Song Shin, 2000. "Rethinking Multiple Equilibria in Macroeconomic Modelling," Cowles Foundation Discussion Papers 1260, Cowles Foundation for Research in Economics, Yale University.
  21. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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