Bank Liquidity Regulation and the Lender of Last Resort
36 Pages Posted: 5 Sep 2007
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: Suggested Citation