Surviving the Perfect Storm: The Role of the Lender of Last Resort

Banco de Portugal, Working Papers 2016

66 Pages Posted: 12 Oct 2016 Last revised: 4 Nov 2020

See all articles by Nuno Alves

Nuno Alves

Banco de Portugal

Diana Bonfim

Banco de Portugal; Catholic University of Portugal (UCP) - Catolica Lisbon School of Business and Economics

Carla Soares

Bank of Portugal

Date Written: November 04, 2020

Abstract

When banks are hit by a severe liquidity shock, central banks have a key role as lenders of last resort. Despite the well-established importance of this mechanism, it is challenging to analyze empirically this key role of central banks. We explore a unique setting in which banks suddenly lost access to market funding due to contagion fears at the onset of the euro area sovereign debt crisis. Using monthly data at the loan, bank, and firm level, we test the role of the central bank in a scenario of imminent collapse. We find that the liquidity obtained from the central bank played a key role in temporarily supporting the supply of credit to the real economy. However, the subdued loan demand, together with moral suasion and carry trade incentives, led to an increase in banks' sovereign bond holdings using central bank funding.

Keywords: lender of last resort, monetary policy, credit channel, financial crisis

JEL Classification: E44, E5, G21

Suggested Citation

Alves, Nuno and Bonfim, Diana and Soares, Carla, Surviving the Perfect Storm: The Role of the Lender of Last Resort (November 04, 2020). Banco de Portugal, Working Papers 2016, Available at SSRN: https://ssrn.com/abstract=2850887 or http://dx.doi.org/10.2139/ssrn.2850887

Nuno Alves

Banco de Portugal ( email )

Diana Bonfim (Contact Author)

Banco de Portugal ( email )

Av Almirante Reis, 71
P-1150-012 Lisboa
Portugal

Catholic University of Portugal (UCP) - Catolica Lisbon School of Business and Economics ( email )

Palma de Cima
Lisbon, 1649-023
Portugal

Carla Soares

Bank of Portugal ( email )

Rua Francisco Ribeiro, 2
Lisbon, 1150-165
Portugal

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