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«Der Open-Access-Publikationsserver der ZBW – Leibniz-Informationszentrum Wirtschaft The Open Access Publication Server of the ZBW – Leibniz ...»

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So obviously, given these additional costs a policy of individual liquidity assistance is only preferable if the welfare gains of this LOLR-policy outweighs these costs. But as we have already argued the gains of an individual liquidity assistance differ with respect to the financial system under consideration. Thus, in a bank-dominated financial system in which the efficiency gains of an individual liquidity assistance are relatively large in moderate as well as in severe liquidity crises it is rather likely that a LOLR prefers to bear the additional information costs in order to be able to pursue this LOLR-policy. In contrast, in market-oriented financial systems, where the drawback of market interventions is in both types of financial crises less severe, the LOLR may decide to save the costs of acquiring the required information for an individual liquidity assistance and use market interventions to provide the banking system with additional liquidity.

Proposition 7 Taking into account, that there are more cost intense information requirements associated with an individual liquidity assistance, a LOLR-policy based on We assume that the LOLR cannot observe the region the bank is located in. Thus, the regions should not be taken literally but can be interpreted as sectors of the economy which are inflicted in different for outsiders not easily observable ways by the macroeconomic shock.

individual liquidity assistance may be preferable in bank-based financial system but not in market-oriented financial systems.

6 Conclusions In this paper on liquidity crises and lender of last resort policies we can distinguish between three different types of crisis situations. In a slight liquidity crisis there is no need for a lender of last resort. No banks are subject to a run, the only thing we observe is a slight increase of interest rates. In contrast, a moderate liquidity crisis is characterized by runs on weak banks. Depositors seize assets and late projects will be restructured. Finally, in a severe liquidity crisis not only runs on weak banks can be observed but also strong banks will be liquidity rationed and have to partially restructure their late projects. Accordingly, in a moderate and in a severe liquidity crisis the intervention of a lender of last resort may be preferable to prevent runs from occurring.

However, from our main results we can draw a connection between financial system configurations and the optimal lender of last resort policy, i.e. a market intervention following Bagehots’ rules and lending liquidity freely at penalty rates, or an individual liquidity assistance provided discretionary by the lender of last resort.

In a moderate as well as in a severe liquidity crisis individual liquidity assistance guarantees a more efficient allocation of the provided liquidity. However, in both crisis situations the welfare losses due to the inefficient waste of liquidity are higher in bankdominated financial systems than in market-oriented financial systems. Thus, taking into account the more costly informational requirements of a lender of last resort that follows a policy of an individual liquidity assistance it may follow that the information costs outweigh the efficiency gain from a individual liquidity assistance in a marketoriented but not in a bank-oriented financial system.

Presumably, this argument in favor of a market intervention in market-oriented financial systems can further be strengthened: By incorporating into the analysis that a market intervention proportionally wastes more liquidity in the moderate than in the severe liquidity crises, we get lower efficiency loss from market intervention in a severe liquidity crisis if the informational costs of the LOLR increase with the amount of liquidity provided on an individual basis. Having in mind that, as we showed in Proposition 3, under reasonable assumption a market-oriented system is more often in a severe than in a moderate liquidity crisis, this also implies lower efficiency losses of a market intervention in a market-oriented system.

Of course, there are important qualifications to this conclusion. Our model is incomplete in at least three aspects, which we want to analyze in future research.

First of all we have to determine endogenously the decision of a lender of last resort to examine and inspect the banks who seek liquidity support in different financial systems.

Secondly, in future work we want to elaborate on the ex ante decision of a bank about investing in projects and in storage technology. Thirdly and may be most important, our model is quiet about possible moral hazard behavior of banks induced by a lender of last resort. The only thing we can say for sure is that in our framework banks in bank-dominated systems acquire higher rents than banks in a market-oriented system, since the activity of the former are more firm-specific. Of course, these differences affect their behavior. In which direction the behavior will be influenced, that would be a very interesting and important topic of the LOLR policy analysis in the context of different financial systems.

References Allen, F., and D. Gale, 1998, “Optimal Financial Crises,” Journal of Finance, 53, 1245–1283.

Allen, F., and D. Gale, 2000, Comparing Financial Systems, MIT Press, Cambridge MA.

Allen, F., and D. Gale, 2001, “Comparpative Financial Systems: A Survey,” Working Paper 01-15,Wharton Financial Institution Center.





Bagehot, W., 1873, Lombard Street, H.S. King, London.

Berlin, M., and L. Mester, 1998, “On the Profitability and Cost of Relationship Lending,” Journal of Banking and Finance, 22, 873–897.

Diamond, D., and R. Rajan, 2000, “A Theory of Bank Capital,” Journal of Finance, 55, 2431–2465.

Diamond, D., and R. Rajan, 2001, “Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking,” Journal of Political Economy, 109, 287–327.

Diamond, D., and R. Rajan, 2002, “Liquidity Shortages and Banking Crises,” Working Paper, University of Chicago.

Diamond, D. W., 1984, “Financial Intermediation and Delegated Monitoring,” Review of Economic Studies, 51, 393–414.

Elsas, R., and J. Krahnen, 1998, “Is Relationship Lending Special? Evidence from Credit-File Data in Germany,” Journal of Banking and Finance, 22, 1283–1316.

Fischer, S., 1999, “On the Need for an International Lender of Last Resort,” Journal of Economic Perspectives, 13, 85–104.

Franks, J., and C. Mayer, 1995, “Ownership and Control,” in H. Siebert (ed.), Trends in Business Organization: Do Participation and Cooperation Increase Competitiveness?

. pp. 171–195, Mohr, Tbingen.

Freixas, X., B. Parigi, and J.-C. Rochet, forthcoming, “The Lender of Last Resort: A 21st Century Approach,” Journal of European Economic Association.

Freixas, X. et al., November 1999, “Lender of Last Resort: A Review of Literature,” Financial Stability Review, pp. 151–167.

Giannini, C., 1999, “Enemy of None but a Common Friend of All? An International Perspectives on the Lender of Last Resort Function,” Princeton Essays in International Finance.

Goodhart, C., 1995, The Central Bank and the Financial System, MIT Press, Cambridge, MA.

Goodhart, C., 1999, “Myths about the Lender of Last Resort,” International Finance, 2, 339–360.

Gorton, G., and C. Kahn, 1992, “The Design of Bank Loan Contracts,” Review of Financial Studies, 13, 331–364.

Hackethal, A., R. H. Schmidt, and M. Tyrell, 2002, “Convergence of Financial Systems in Europe,” Schmalenbach Business Review, pp. 7–54.

Kahn, C., and J. Santos, 2001, “Allocating Bank Regulatory Powers: Lender of Last Resort, Deposit Insurance and Supervision,” Working Paper 102, Bank for International Settlements.

Lindgren, C., G. G., and M. Saal, 1996, Bank Soundness and Macroeconomic Policy,, International Monetary Fund, Washington, D.C.

Rajan, R., 1992, “Insiders and Outsiders: The Choice between informed and arm‘s length debt,” Journal of Finance, 47, 1113–1146.

Repullo, R., 2000, “Who Should Act as a Lender of Last Resort? An Incomplete Contract Model,” Journal of Money, Credit and Banking, 32, 580–605.

Rochet, J.-C., and X. Vives, 2002, “Coordination Failures and the Lender of Last Resort Was Bagehot Right After All?,” Working Paper, Universit de Toulouse and Universitat Autnoma de Barcelona.

Thornton, H., 1802, An Enquiry into the Nature and Effects of Paper Credit of Great Britain, Hatchard, London.

Tyrell, M., 2003, Kapitalmaerkte und Banken - Formen der Informationsverarbeitung als konstitutives Merkmal, Gabler, Wiesbaden.

The following Discussion Papers have been published since 2003:

Series 1: Studies of the Economic Research Centre

–  –  –

16 2003 Exact tests and confidence sets for the Jean-Marie Dufour tail coefficient of α-stable distributions Jeong-Ryeol Kurz-Kim

–  –  –

3 2004 Policy Instrument Choice and Non-Coordinated Giovanni Lombardo Monetary Policy in Interdependent Economies Alan Sutherland

–  –  –

8 2004 A rental-equivalence index for owner-occupied Claudia Kurz housing in West Germany 1985 to 1998 Johannes Hoffmann 9 2004 The Inventory Cycle of the German Economy Thomas A. Knetsch

–  –  –

12 2004 Business Cycle Transmission from the US to Germany – a Structural Factor Approach Sandra Eickmeier 13 2004 Consumption Smoothing Across States and Time: George M.

International Insurance vs. Foreign Loans von Furstenberg

–  –  –

15 2004 Welfare Implications of the Design of a Currency Union in Case of Member Countries of Different Sizes and Output Persistence Rainer Frey

–  –  –

Visiting researcher at the Deutsche Bundesbank The Deutsche Bundesbank in Frankfurt is looking for a visiting researcher. Visitors should prepare a research project during their stay at the Bundesbank. Candidates must hold a Ph D and be engaged in the field of either macroeconomics and monetary economics, financial markets or international economics. Proposed research projects should be from these fields. The visiting term will be from 3 to 6 months. Salary is commensurate with experience.

Applicants are requested to send a CV, copies of recent papers, letters of reference and a

proposal for a research project to:

Deutsche Bundesbank Personalabteilung Wilhelm-Epstein-Str. 14 D - 60431 Frankfurt GERMANY



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