Overcoming Borrowing Stigma: The Design of Lending-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 (DW), but actively participated in its special monetary program, the Term Auction Facility (TAF), although both programs had the \emph{same} borrowing requirements. Using an adverse selection model with endogenous borrowing decisions, we explain why two programs suffer from different stigma and how the introduction of TAF incentivized banks' borrowing. We synthesize several data sources to confirm our main theoretical predictions.

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

JEL Classification: G01, E52, D44, E58