Insuring Banks Against Liquidity Shocks: The Role of Deposit Insurance and Lending of Last Resort

24 Pages Posted: 21 Jun 2006

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Abstract

It has long been recognized that banks' simultaneous provision of monitoring and liquidity services is advantageous but leaves them susceptible to liquidity shocks that may culminate in a system failure. Because a system failure is costly, this provides a rationale for adopting arrangements, including a lender of last resort and deposit insurance (DI), to insure banks against liquidity shocks. These arrangements have proven themselves very successful, but they have also been the source of problems. Researchers have identified some of the main sources of these problems and have suggested ways to improve the design of these arrangements, but there are still many issues that remain unaddressed. This paper reviews the literature on the two arrangements that most countries have adopted to insure banks against liquidity shocks, a lender of last resort and DI, and compares the design of these arrangements across countries. The paper ends with a brief summary of the key lessons learned about the design of these arrangements and the issues related to them that remain unaddressed.

Suggested Citation

Santos, João A. C., Insuring Banks Against Liquidity Shocks: The Role of Deposit Insurance and Lending of Last Resort. Journal of Economic Surveys, Vol. 20, No. 3, pp. 459-482, July 2006, Available at SSRN: https://ssrn.com/abstract=909641 or http://dx.doi.org/10.1111/j.0950-0804.2006.00286.x

João A. C. Santos (Contact Author)

Federal Reserve Bank of New York ( email )

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