Surviving the perfect storm: The role of the lender of last resort☆ |
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| Institution: | 1. Banco de Portugal, Economics and Research Department, Av, Almirante Reis 71, 1150-015 Lisbon, Portugal;1. ALBA Graduate Business School, The American College of Greece, 6-8 Xenias Str, 11528 Athens, Greece;2. Bank of Greece, 21 E. Venizelos Ave., 10250 Athens, Greece;3. University of Piraeus, Department of Banking and Financial Management, 80 Karaoli & Dimitriou str., 18534 Piraeus, Greece;4. Surrey Business School, University of Surrey, Guildford, Surrey, GU2 7XH, United Kingdom;1. D’Amore-McKim School of Business, Northeastern University, USA;2. Olin Business School, Washington University in St. Louis, USA;1. Professor at Universitat Pompeu Fabra, Barcelona Graduate School of Economics and CEPR, Ramon Trias Fargas, 25-27 08005 Barcelona, Spain;2. Associate professor at Universidad de los Andes. Calle 19A No 1-37 Este, Bloque W, Bogotá, 111711, Colombia;1. Henry Kaufman Professor of Financial Institutions at Columbia Business School and NBER Research Associate, New York, NY 10027, United States;2. Department of International History, Graduate Institute for International Studies and Development in Geneva, Geneva, Switzerland;3. European Central Bank and CEPR Research Fellow, Frankfurt, Germany;1. Cass Business School, London, United Kingdom;2. CEPR, United Kingdom;3. Bank for International Settlements, Basel, Switzerland;1. Johnson Graduate School of Business, Cornell University, 401H Sage Hall, Ithaca, NY 14850, USA;2. Jones Graduate School of Business, Rice University, 6100 S Main St, MS-531, Houston, TX 77005, USA;3. U.S. Securities and Exchange Commission, 100 F St NE, Washington D.C. 20549, USA;4. Tulane University, 7 McAlister Dr., New Orleans, LA 70118, USA |
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| Abstract: | When banks are hit by a severe liquidity shock, central banks have a key role as lenders of last resort. Despite the well-established importance of this mechanism, it is challenging to analyze it empirically. We explore a unique setting in which banks suddenly lost access to market funding due to contagion fears at the onset of the euro area sovereign debt crisis. Using monthly data at the loan, bank, and firm level, we test the role of the central bank in a scenario of imminent collapse. We find that the liquidity obtained from the central bank played a key role in temporarily supporting the supply of credit to the real economy. However, the subdued loan demand, together with moral suasion and carry trade incentives, led to an increase in banks’ sovereign bond holdings using central bank funding. |
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