Overcoming Borrowing Stigma: The Design of Lending-of-Last-Resort Policies
37 Pages Posted: 8 Nov 2018 Last revised: 17 Apr 2019
Date Written: April 15, 2019
How should the government effectively provide liquidity to banks during periods of financial distress? During the most recent financial crisis, banks avoided borrowing from the Fed's Discount Window (DW) but bid more in its Term Auction Facility (TAF), although both programs share similar requirements on participation. Moreover, some banks paid higher interest rates in the auction than the concurrent discount rate. Using a model with endogenous borrowing stigma, we explain how the combination of the DW and the TAF increased banks' borrowings and willingnesses to pay for loans from the Fed. Using micro-level data on DW borrowing and TAF bidding from 2007 to 2010, we confirm our theoretical predictions about the pre-borrowing and post-borrowing conditions of banks in different facilities. Finally, we discuss the design of lending-of-last-resort policies.
Keywords: discount window stigma, auction, adverse selection, lending of last resort
JEL Classification: G01, D44, E58
Suggested Citation: Suggested Citation