The Lender of Last Resort: Liquidity Provision Versus the Possibility of Bail-Out

Eijffinger, Sylvester; Nijskens, Rob

doi:10.2139/ssrn.1543742

Cited by 2 publications

(1 citation statement)

References 9 publications

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“…The LLR has to make a trade-off between moral hazard and contagion risk (Goodhart and Second, to avoid moral hazard, 'constructive ambiguity' has been introduced while exercising the LLR mechanism aside from penalty rates, which means that: (1) the LLR would not deliberately assure financial institutions beforehand that it would provide liquidity when this is required, so the financial institutions can operate in a prudent manner; (2) during the bailout assistance, in order to ensure smooth implementation, the instruments and targeted institutions are confidential; and (3) subsequent timely information disclosure is vital in order to eliminate public distrust arising from any perceived 'covert operations'. Moreover, the discretion of the LLR is also subject to supervision (Goodhart and Huang 1999;Nijskens and Eijffinger 2010;Repullo 2005).…”

Section: Implementation Of the Concept Of Llrmentioning

confidence: 99%

The Institutional Innovation of the Lender of Last Resort Facility in the Eurozone

2014

Journal of European Integration

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The eurozone has experienced a liquidity squeeze since the outbreak of the European debt crisis, leading to a crisis of confidence. Whether the European Central Bank (ECB) can become the Lender of Last Resort (LLR) has become the focus of discussions. The author begins by clarifying the definition of the LLR, and then analyses the possibility of the ECB or other institutions assuming the role of the LLR, taking into account the eurozone's special economic governance model and legal framework. As the conclusion shows, with the introduction of Outright Monetary Transactions (OMTs), a debt-purchasing programme, the ECB and the European Stability Mechanism (ESM) will jointly act as the eurozone LLR.

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Section: Implementation Of the Concept Of Llrmentioning

confidence: 99%

The Institutional Innovation of the Lender of Last Resort Facility in the Eurozone

2014

Journal of European Integration

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Securitization, Risk‐Taking and the Option to Change Strategy

Lai¹,

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2014

Real Estate Economics

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This article models the riskiness of structured securitization deals. The deals are put together by "banks," which can exercise strategic options over the risk put into the deals. The banks face a trade-off between the benefits of risktaking now and future franchise benefits if the deal pays off. The key insight is a convex relationship between the value of the bank's equity position and the risk in the deal. Although there is a continuum of possible risk, banks choose either the highest or lowest levels of risk open to them. Changes in strategy are discontinuous and unpredictable; a history of low risk-taking may be a prelude to increased risk-taking later. Competition, to the extent of reducing franchise value, can lead to more risk-taking, as can more information in the market. The model provides insights into the risk-taking that led up to the Great Recession and to institutions that are "Too Big to Fail." Risk-taking, particularly abrupt changes in risk-taking, was at the core of the recent boom and bust in U.S. real estate markets. This was manifested in the market for mortgage-backed securities, where there was a rapid change in the structure of the mortgage market from 2003 to 2005, as the growth of lower quality "private label" securities accelerated and there was an increase in mortgage types that made risk-taking easier (e.g., loans without full documentation; see Anderson, Capozza andVan Order 2011 andAshcraft andSchuermann 2008).Financial institutions have the ability to exercise strategic options when the holders of their liabilities have limited information and limited control over risk-taking. We focus on two options: (1) choice of assets so that the volatility of the portfolio backing the liabilities is higher than what the market believes and (2) the option to change strategy in response to changes in data. Our focus here will be on structured securitization, but similar analysis can be made of the behavior of financial institutions like banks and government-sponsored enterprises (GSEs) like We develop a model of risk-taking in securitization deals in which deal sponsors optimize the value of their options when putting together the deals. The model has a "bang-bang" solution; the structure either takes on a high level of risk or low level of risk even though there are feasible levels in between. This is not new in corporate finance models. For instance, Ross (1997) and Leland (1998) develop models of corporate risk-taking that have similar properties. In their models, the solutions depend on taxes and bankruptcy costs. Firms that would ordinarily take as much risk as they could get away with in order to maximize the shareholder value take less risk because bankruptcy costs increase the cost of risk-taking. This leads to a critical level of bankruptcy cost above which firms choose the safe strategy and below which they choose the risky strategy, which leads to "bang-bang" solutions as cost moves above or below the critical level. However, those models are not applicable to structured deals in whi...

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The Lender of Last Resort: Liquidity Provision Versus the Possibility of Bail-Out

Cited by 2 publications

References 9 publications

The Institutional Innovation of the Lender of Last Resort Facility in the Eurozone

The Institutional Innovation of the Lender of Last Resort Facility in the Eurozone

Securitization, Risk‐Taking and the Option to Change Strategy

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