Monitoring, Liquidity and Financial Crises

Gabriela Mundaca

MPRA Paper from University Library of Munich, Germany

Abstract: This paper analyzes central bank policies on the monitoring of banks in distress in which liquidity provisions are conditional on performance when a bad shock occurs. A sequential game model is used to analyze two policies: the first one in which the central bank acts with discretion and the second in which the optimal monitoring policy rule is made public. The results show that banks exert less effort and take higher risks with a discretionary monitoring policy. With public information about monitoring rules, there is more central bank monitoring and less need to provide emergency funding. Public information about monitoring resolves the multiple equilibria that arise with discretion in fact, a unique equilibrium emerges in which the probability of a banking crisis is reduced.

Keywords: monitoring; liquidity; provision; financial; crises; conditionality (search for similar items in EconPapers)
JEL-codes: E58 G21 G28 G38 (search for similar items in EconPapers)
Date: 2008-03-10, Revised 2009-10-01
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:20501

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