Inversion and Lender of last resort: Difference between pages

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1.
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 term used in foreign exchange rate quotation.
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.
 
 
'''Example'''
 
Consider the historical FX quote:
 
GBP 1 = 1.4598 - 1.4602 USD.
 
The base currency is GBP.
 
This is the currency there is a single unit of, to be exchanged for a variable number of USD.
 
 
The inversion of this FX quote means expressing the same price, but with the other currency as the base currency (USD here):
 
USD 1 = (1 / 1.4602) - (1 / 1.4598) GBP
 
USD 1 = 0.6848 - 0.6850 GBP.
 
 
In the inverted FX quote, USD is the currency there is a single unit of (to be exchanged for a variable number of GBP).
 
 
2.
 
In any market, the reversal of a normal - or commonly expected - relationship.
 
For example the situation of an Inverse yield curve, where longer maturities of funds are trading at LOWER yields than shorter-dated maturities (being the opposite of the normally expected upward-sloping relationship).


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]].


== See also ==
== See also ==
* [[Base currency]]
* [[Central bank]]
* [[Foreign exchange]]
* [[Inverse yield curve]]
* [[Reciprocal]]
* [[Tax inversion]]
 
[[Category:Manage_risks]]

Revision as of 13:31, 2 August 2013

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.

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.

See also

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