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Monitoring, liquidity provision and financial crisis

Author

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  • Mundaca, B. Gabriela

    (Ragnar Frisch Centre for Economic Research)

Abstract

This paper analyzes central bank policies on monitoring banks in distress when liquidity provisions are conditional on performance and a bad shock occurs. A sequential game model is used to analyze two policies: one in which the central bank acts with discretion and the second in which the optimal monitoring policy rule is made public. The results show that banks exert less effort and take higher risks with discretionary monitoring policy. With public information about monitoring rules, there is more central bank monitoring and less need to provide emergency financing. Public information about monitoring resolves the multiple equilibria that arise with discretion and a unique equilibrium emerges where the probability of banking crisis is reduced.

Suggested Citation

  • Mundaca, B. Gabriela, 2007. "Monitoring, liquidity provision and financial crisis," Memorandum 04/2007, Oslo University, Department of Economics, revised 01 Mar 2009.
    • Handle: RePEc:hhs:osloec:2007_004
    as

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    File URL: http://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2007/Memo-04-2007.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Monitoring; bailouts; banking crises; commitments; conditionality;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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