Liquidity, Risk-Taking and the Lender of Last Resort

Rafael Repullo

No 4967, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper studies the strategic interaction between a bank whose deposits are randomly withdrawn, and a lender of last resort (LLR) that bases its decision on supervisory information on the quality of the bank?s assets. The bank is subject to a capital requirement and chooses the liquidity buffer that it wants to hold and the risk of its loan portfolio. The equilibrium choice of risk is shown to be decreasing in the capital requirement, and increasing in the interest rate charged by the LLR. Moreover, when the LLR does not charge penalty rates, the bank chooses the same level of risk and a smaller liquidity buffer than in the absence of a LLR. Thus, in contrast with the general view, the existence of a LLR does not increase the incentives to take risk, while penalty rates do.

Keywords: Central bank; Lender of last resort; Penalty rates; Moral hazard; Bank supervision; Capital requirements; Deposit insurance (search for similar items in EconPapers)
JEL-codes: E58 G21 G28 (search for similar items in EconPapers)
Date: 2005-03
New Economics Papers: this item is included in nep-fin, nep-fmk, nep-mac and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (74)

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Related works:
Journal Article: Liquidity, Risk Taking, and the Lender of Last Resort (2005)
Working Paper: Liquidity, Risk-Taking, and the Lender of Last Resort (2005)
Working Paper: Liquidity, Risk Taking, and the Lender of Last Resort (2005)
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