Articles
The Lender of Last Resort Function: Current Interpretation of Bagehot Principles
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AuthorChul Won Ahn
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Year2009
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VolumeVol.57
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NumberNo.1
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The lender of last resort function of central banks was practically established
in the ‘Lombard Street(1873)’ of Walter Bagehot. In this book, Bagehot
suggested that in a liquidity crisis, a central bank should lend freely, at a high
interest rate, to illiquid but solvent individual banks with good collateral and
make clear in advance the central bank’s readiness to lend. Bagehot proposed
these principles ‘to avoid crisis by preventing alarm’ and ‘to use Bank’s reserve
efficiently.’ Since then there have been many discussions and disputes on these
principles because of changes in economic and policy situations and because of
considerations of moral hazard. But actually as the financial crisis grows
serious, the principles, particularly those of ‘penalty rate’ and ‘no lending to
insolvent institutions’ were loosened. On the other hand, the principles of clear
recognition of central bank’s financial stability mandate, the necessity and
importance of communication, and the immediate reaction by rules deserve
more attention and should be reemphasized. -
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