Publication
The Korean Journal of Economic Studies
The Lender of Last Resort Function: Current Interpretation of Bagehot Principles
Chul Won AhnYear 2009Vol. 57No. 1
Abstract
The lender of last resort function of central banks was practically establishedin the ‘Lombard Street(1873)’ of Walter Bagehot. In this book, Bagehotsuggested that in a liquidity crisis, a central bank should lend freely, at a highinterest rate, to illiquid but solvent individual banks with good collateral andmake clear in advance the central bank’s readiness to lend. Bagehot proposedthese principles ‘to avoid crisis by preventing alarm’ and ‘to use Bank’s reserveefficiently.’ Since then there have been many discussions and disputes on theseprinciples because of changes in economic and policy situations and because ofconsiderations of moral hazard. But actually as the financial crisis growsserious, the principles, particularly those of ‘penalty rate’ and ‘no lending toinsolvent institutions’ were loosened. On the other hand, the principles of clearrecognition of central bank’s financial stability mandate, the necessity andimportance of communication, and the immediate reaction by rules deservemore attention and should be reemphasized.