Working Paper: CEPR ID: DP4967
Authors: Rafael Repullo
Abstract: This paper studies the strategic interaction between a bank whose deposits are randomly withdrawn, and a lender of last resort (LLR) that bases its decision on supervisory information on the quality of the bank?s assets.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: bank supervision; capital requirements; central bank; deposit insurance; lender of last resort; moral hazard; penalty rates
JEL Codes: E58; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Capital Requirement (G32) | Equilibrium Choice of Risk (D81) |
| Interest Rate Charged by LLR (E43) | Equilibrium Choice of Risk (D81) |
| LLR Penalty Rates (K34) | Liquidity Buffer (E41) |
| LLR Penalty Rates (K34) | Equilibrium Choice of Risk (D81) |
| LLR Intervention (I24) | Liquidity Buffer (E41) |
| LLR Intervention (I24) | Equilibrium Choice of Risk (D81) |