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Liquidity, Risk-Taking and the Lender of Last Resort

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  • Repullo, Rafael

Abstract

This paper studies the strategic interaction between a bank whose deposits are randomly withdrawn, and a lender of last resort (LLR) that bases its decision on supervisory information on the quality of the bank?s assets. The bank is subject to a capital requirement and chooses the liquidity buffer that it wants to hold and the risk of its loan portfolio. The equilibrium choice of risk is shown to be decreasing in the capital requirement, and increasing in the interest rate charged by the LLR. Moreover, when the LLR does not charge penalty rates, the bank chooses the same level of risk and a smaller liquidity buffer than in the absence of a LLR. Thus, in contrast with the general view, the existence of a LLR does not increase the incentives to take risk, while penalty rates do.

Suggested Citation

  • Repullo, Rafael, 2005. "Liquidity, Risk-Taking and the Lender of Last Resort," CEPR Discussion Papers 4967, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:4967
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    More about this item

    Keywords

    Central bank; Lender of last resort; Penalty rates; Moral hazard; Bank supervision; Capital requirements; Deposit insurance;
    All these keywords.

    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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