Encyclopedia of Law and Economics

2019 Edition
| Editors: Alain Marciano, Giovanni Battista Ramello

Lender of Last Resort

  • Uwe VollmerEmail author
Reference work entry
DOI: https://doi.org/10.1007/978-1-4614-7753-2_75

Definition

A lender of last resort (LoLR) is an institution, usually the central bank (CB) or a public deposit insurer (DI), which offers emergency financial assistance to commercial banks particularly during a financial crisis. In most cases, financial assistance means provision of liquidity to a single financial institution or to the financial market as a loan (liquidity assistance), usually against first-class collateral. Sometimes, the LoLR also recapitalizes commercial banks and provides risk-capital support that has not to be paid back (bank bailout).

Origin

The need for a CB to provide liquidity assistance was first mentioned by Henry Thornton (1802/1939) and advanced byWalter Bagehot (1873) who elaborated the9 principles applied to a policy of an LoLR. He proposed that the Bank of England should announce in advance its readiness to lend against collateral any amount to an illiquid but solvent financial institution at a penalty rate of interest. Bagehot suggested that during a...

This is a preview of subscription content, log in to check access.

References

  1. Acharya VV (2009) A theory of systemic risk and design of prudential bank regulation. J Financ Stab 5(3):224–255CrossRefGoogle Scholar
  2. Acharya VV, Yorulmazer T (2008) Cash-in-the-market pricing and optimal resolution of bank failures. Rev Financ Stud 21(6):2705–2742CrossRefGoogle Scholar
  3. Allen F, Gale D (2000) Financial contagion. J Polit Econ 108(1):1–33CrossRefGoogle Scholar
  4. Bagehot W (1873) Lombard street: a description of the money market. Dodo Press, London (reprint)Google Scholar
  5. Bebenroth R, Dietrich D, Vollmer U (2009) Bank regulation and supervision in bank-dominated financial systems: a comparison between Japan and Germany. Eur J Law Econ 27(2):177–209CrossRefGoogle Scholar
  6. Beck T (2002) Deposit insurance as a private club: is Germany a model? Q Rev Econ Finance 42:701–719CrossRefGoogle Scholar
  7. Bordo MD (1990) The lender of last resort: alternative views and historical experience. Fed Reserve Bank Richmond Econ Rev. 18–29 Jan/FebGoogle Scholar
  8. Castiglionesi F, Wagner W (2012) Turning Bagehot on his head: lending at penalty rates when banks can become insolvent. J Money Credit Bank 44(1):201–219CrossRefGoogle Scholar
  9. Chaney PK, Thakor AV (1985) Incentive effects of benevolent intervention: the case of government loan guarantees. J Public Econ 26(2):169–189CrossRefGoogle Scholar
  10. Chari VV, Jagannathan R (1988) Banking panics, information, and rational expectations equilibrium. J Financ 43(3):749–761CrossRefGoogle Scholar
  11. Cordella T, Yeyati EL (2003) Bank “bailouts”: moral hazard vs. value effect. J Financ Intermed 12:300–330CrossRefGoogle Scholar
  12. Demirgüç-Kunt A, Huizinga H (2004) Market discipline and financial insurance. J Monet Econ 51(2):375–399CrossRefGoogle Scholar
  13. Diamond D, Dybvig P (1983) Bank runs, deposit insurance, and liquidity. J Polit Econ 91:401–419CrossRefGoogle Scholar
  14. Eisenschmidt J, Tapking J (2009) Liquidity risk premia in unsecured interbank money markets. European Central Bank working paper 1025Google Scholar
  15. Flannery M (1996) Financial crises, payment system problems, and discount window lending. J Money Credit Bank 28:804–824CrossRefGoogle Scholar
  16. Freixas X (2000) Optimal bail out policy, conditionality and constructive ambiguity. Netherlands Central Bank, DNB staff reports 49, AmsterdamGoogle Scholar
  17. Freixas X, Giannini C, Hoggarth G, Soussa F (2000a) Lender of last resort: what have we learned since Bagehot? J Financ Serv Res 18(1):63–84CrossRefGoogle Scholar
  18. Freixas X, Parigi BM, Rochet J-C (2000b) Systemic risk, interbank relations, and liquidity provision by the central bank. J Money Credit Bank 32(3):611–638CrossRefGoogle Scholar
  19. Goodhart CAE (1999) Myths about the lender of last resort. Int Financ 2(3):339–360CrossRefGoogle Scholar
  20. Goodhart C, Schoenmaker D (1995) Should the functions of monetary policy and banking supervision be separated? Oxf Econ Pap 47:539–560CrossRefGoogle Scholar
  21. Gropp R, Hakenes H, Schnabel I (2010) Competition, risk-shifting, and public bail-out policies. Rev Financ Stud 25(8):2343–2380Google Scholar
  22. Heider F, Hoerova M, Holthausen C (2009) Liquidity hoarding and interbank market spreads: the role of counterparty risk. European Central Bank working paper 1126Google Scholar
  23. Jacklin C, Bhattacharya S (1988) Distinguishing panics and information-based bank runs: welfare and policy implications. J Polit Econ 96:568–592CrossRefGoogle Scholar
  24. Kahn CM, Santos JAC (2005) Allocating bank regulatory powers: lender of last resort, deposit insurance and supervision. Eur Econ Rev 49:2107–2136CrossRefGoogle Scholar
  25. Kaufman G (1991) Lender of last resort: a contemporary perspective. J Financ Serv Res 5(2):123–150CrossRefGoogle Scholar
  26. Kindleberger C (1989) Manias, panics, and crashes: a history of financial crises. Basic Books, New YorkCrossRefGoogle Scholar
  27. Nakaso H (2001) The financial crisis in Japan during the 1990s: how the Bank of Japan responded and the lessons learnt. BIS papers no 6, BaselGoogle Scholar
  28. Perotti E, Suarez J (2002) Last bank standing: what do I gain if you fail? Eur Econ Rev 46:1599–1622CrossRefGoogle Scholar
  29. Petrovic A, Tutsch R (2010) National rescue measures in response to the current financial crisis. European Central Bank, legal working paper series no 8, Frankfurt/MainGoogle Scholar
  30. Repullo R (2000) Who should act as lender of last resort? An incomplete contracts model. J Money Credit Bank 32:580–605CrossRefGoogle Scholar
  31. Repullo R (2005) Liquidity, risk taking, and the lender of last resort. Int J Cent Bank 2(2):47–80Google Scholar
  32. Rochet J-C, Vives X (2004) Coordination failures and the lender of last resort: was Bagehot right after all? J Eur Econ Assoc 2(6):1116–1147CrossRefGoogle Scholar
  33. Saunders A, Wilson B (1996) Contagious bank runs: evidence from the 1929–1933 period. J Financ Intermed 5(4):409–423CrossRefGoogle Scholar
  34. Thornton H (1802/1939) An enquiry into the nature and effects of the paper credit of Great Britain (ed with an introduction by FA von Hayek). George Allen and Unwin, LondonGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  1. 1.University of LeipzigLeipzigGermany