Dealer Financial Conditions and Lender-of-Last-Resort Facilities
51 Pages Posted: 17 Mar 2012
Date Written: March 15, 2012
Do central bank lender-of-last-resort (LOLR) facilities elicit greater and more aggressive participation from less capitalized financial firms? We answer this question by examining financial conditions of dealers that participated in the Federal Reserve’s Term Securities Lending Facility (TSLF), a LOLR facility that provided liquidity against a range of assets during 2008-09. We find that, in the cross-section, dealers with more leverage and lower equity returns prior to a TSLF auction were more likely to participate in the auction and bid more aggressively (i.e., bid more and at higher bidding rates). These effects were stronger for auctions that allowed tendering of more illiquid collateral. We find some support for reluctance of firms to participate given a lack of participation in earlier auctions, but such “stigma“ does not fully explain the effect of leverage in inducing greater participation. Our results suggest the importance of considering solvency concerns of banks when designing LOLR facilities during times of aggregate liquidity shortages.
Keywords: lender of last resort, central banking, crises, illiquidity, insolvency, stigma
JEL Classification: G01, G28, E58, D44
Suggested Citation: Suggested Citation