Stock Liquidity Requirements and the Insurance Aspect of the Lender of Last Resort

Spyros Pagratis
Additional contact information
Spyros Pagratis: Bank of England

International Journal of Central Banking, 2007, vol. 3, issue 3, 119-146

Abstract: This paper considers a model of information-based bank runs where a central bank sets its lender of last resort (LOLR) policy in order to maximize welfare. To mitigate the risks associated with overinvestment by the banking sector, the central bank sets prudential liquidity requirements for the banking sector in the form of a ratio of liquid assets to deposits. Liquidity requirements then provide a buffer against early deposit withdrawals, but they also allow the central bank to manufacture a distribution of costs to LOLR funding with an expected value equal to 0. It is shown that liquidity requirements, along with an appropriate LOLR policy, become welfare improving if the banking sector is characterized by high-profit opportunities, low leverage, and a relatively volatile deposit base. Otherwise, forgone productive investment due to liquidity restrictions may result in a disproportional cost to the banking sector relative to the insurance value of LOLR.

JEL-codes: E58 G28 (search for similar items in EconPapers)
Date: 2007
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.ijcb.org/journal/ijcb07q3a4.pdf (application/pdf)
http://www.ijcb.org/journal/ijcb07q3a4.htm (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ijc:ijcjou:y:2007:q:3:a:4

Access Statistics for this article

International Journal of Central Banking is currently edited by Loretta J. Mester

More articles in International Journal of Central Banking from International Journal of Central Banking
Bibliographic data for series maintained by Bank for International Settlements ().