Borrowing Stigma and Lender of Last Resort Policies

Abstract

How should the lender of last resort provide liquidity to banks during periods of financial distress? During the 2008-2010 crisis, banks avoided borrowing from the Fed's long-standing discount window but actively participated in its special monetary program, the Term Auction Facility, although both programs had the same borrowing requirements. Using an adverse selection model with endogenous borrowing decisions, we explain why the two programs suffer from different stigma costs and how the introduction of TAF incentivized banks' borrowing. We discuss the empirical relevance of the model's predictions.

Keywords: lending of last resort, discount window stigma, Term Auction Facility, adverse selection

JEL Classification: G01, E52, D44, E58