Abstract and Keywords
Central banks play an important role as lender of last resort (LOLR) to banks experiencing liquidity problems. This article examines this LOLR function, and its relationship with bank closure policy. It considers the justification of LOLR lending in a simplified framework where only liquidity shocks arise. It then examines contagion in the interbank market. The next section is devoted to the case where liquidity shocks cannot be disentangled from solvency ones. This is followed by a discussion of the issues raised by the implementation and decentralization of the LOLR policy within the safety net.
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