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Emergency liquidity injections

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  • Garvin, Nicholas

Abstract

This paper models emergency liquidity injection policies intended to prevent illiquidity-driven bank failures. A system-wide withdrawal of funding liquidity causes bank failures if banks’ securities have low market liquidity relative to the withdrawal size. The model presents several policy implications. Requiring banks to collateralise emergency lending with illiquid securities has positive externalities in the securities’ secondary markets, by constraining banks’ fire selling. For penalty rates on emergency lending to credibly mitigate moral hazard, the loans should be long term, due after the liquidity distress subsides. Additional policy implications relate to penalty rates, haircuts and government balance-sheet expansion.

Suggested Citation

  • Garvin, Nicholas, 2024. "Emergency liquidity injections," International Review of Economics & Finance, Elsevier, vol. 89(PA), pages 1496-1513.
    • Handle: RePEc:eee:reveco:v:89:y:2024:i:pa:p:1496-1513
    DOI: 10.1016/j.iref.2023.08.016
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    More about this item

    Keywords

    Bailout; Banking crisis; Collateral; Liquidity; Moral hazard;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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