Bank Liquidity Regulation and the Lender of Last Resort

36 Pages Posted: 5 Sep 2007

See all articles by Lev Ratnovski

Lev Ratnovski

International Monetary Fund; European Central Bank, Financial Research Division

Abstract

Banks can make suboptimal liquidity choices and gamble for lender of last resort (LOLR) support. Endogenous bailout rents are driven by the need to preserve bankers' incentives under uncertain net worth. In equilibrium, banks can herd in risk management, choosing suboptimal liquidity when they expect others to do so. Optimal liquidity can be restored by quantitative requirements, but such regulation is costly. An LOLR policy incorporating bank capital information can reduce distorting rents and allow for a more efficient solution, but may only be possible in transparent economies.

Keywords: Liquidity, Bank regulation, Lender of last resort, Bailout, Transparency

JEL Classification: G21, G28, E58

Suggested Citation

Ratnovski, Lev, Bank Liquidity Regulation and the Lender of Last Resort. Journal of Financial Intermediation, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1012285

Lev Ratnovski (Contact Author)

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

HOME PAGE: http://ratnovski.googlepages.com

European Central Bank, Financial Research Division

Germany

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