Reserve Bank Governor Glenn Stevens has spoken about the role of central banks as providers of liquidity and as lenders of last resort in times of crisis in this speech.
He defined "lender of last resort" as follows:
the role of lender of last resort [is] where the central bank lends to one
specific entity, when no‑one else will. The first question is: why do
we need it? The reason is the possibility – albeit a very remote one –
that a panic could put overwhelming pressure on a perfectly sound
institution that, though prudently managed, cannot possibly hold enough
liquid assets to withstand the pressure unaided. Some entity has to be
prepared to lend in such a situation if the market will not, otherwise
the panic can imperil the institution concerned, and perhaps the
financial system as well.
He summarised the general lessons from the recent events as follows:
One key lesson is the importance of liquidity in markets and to
institutions, something that perhaps had not been emphasised as much as
it should have been in regulation, where the emphasis has been very
much on capital. We have further learned that, under conditions of
great uncertainty, liquidity pressures can erupt in markets that had
seldom been affected in the past. Central banks have responded quickly
and flexibly to such events, but it has proven difficult to contain the
pressures fully. Some quite important questions remain for the longer
run, which central banks will be considering.
A second
lesson is the difficulty in resolving a problem with an individual
institution under strained overall conditions. Bagehot’s formula
provides only the most general of guidance; making it operational
requires considerable judgement. If and when such an event comes, it
tends to have its own unique elements and a particular set of
circumstances as backdrop. Speed and flexibility in response are
essential. So is consistent and early communication, since disclosure
of support, if not managed very carefully, could turn out to make the
situation worse rather than better.
A third lesson is
that a loan of last resort is, in the end, probably simply bridging
finance while a takeover or major re‑structure of the recipient
institution is organised. The recipient would very likely see a change
in its business model, management, board and ownership structure. It
could well require a pretty clear statement of temporary government
support. All of this would need to be organised very quickly.
