Lender of last resort: Difference between revisions
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A concession given to a select number of financial institutions whereby their central bank agrees to provide them with funds if they should get into [[liquidity]] difficulties. | A concession given to a select number of financial institutions whereby their central bank agrees to provide them with funds if they should get into [[liquidity]] difficulties. | ||
The primary purpose of the activity by the central bank is stability of the financial system. Secondarily, the purpose is stability of the particular institution affected. | The primary purpose of the activity by the central bank is stability of the financial system as a whole. | ||
Secondarily, the purpose is stability of the particular institution affected. | |||
Central banks generally avoid risk taking behaviour. | |||
Accordingly, in principle, the central banks only lend against good security ([[collateral]]) and with a conservative [[haircut]]. | |||
In practice, liquidity shortage may force a bank to seek to dispose of assets, even at significant losses that erode its capital. | |||
Eventually the central bank may lend against less-good collateral and with less than its desired haircut on collateral valuation - until it won't, when the game is over and the story becomes one of [[resolution]]. | |||
Lender of last resort activity is also often referred to as emergency liquidity assistance. | |||
The European Central Bank's scheme is called Emergency Liquidity Assistance (ELA), for example. | |||
== See also == | == See also == | ||
* [[Central bank]] | * [[Central bank]] | ||
* [[Emergency liquidity assistance]] | |||
* [[Financial stability]] | |||
* [[Market maker of last resort]] | |||
[[Category:Accounting,_tax_and_regulation]] | |||
[[Category:The_business_context]] | |||
Latest revision as of 17:33, 1 July 2022
A concession given to a select number of financial institutions whereby their central bank agrees to provide them with funds if they should get into liquidity difficulties.
The primary purpose of the activity by the central bank is stability of the financial system as a whole.
Secondarily, the purpose is stability of the particular institution affected.
Central banks generally avoid risk taking behaviour.
Accordingly, in principle, the central banks only lend against good security (collateral) and with a conservative haircut.
In practice, liquidity shortage may force a bank to seek to dispose of assets, even at significant losses that erode its capital.
Eventually the central bank may lend against less-good collateral and with less than its desired haircut on collateral valuation - until it won't, when the game is over and the story becomes one of resolution.
Lender of last resort activity is also often referred to as emergency liquidity assistance.
The European Central Bank's scheme is called Emergency Liquidity Assistance (ELA), for example.
