How much financial strength information do central banks need? 26.04.2017 How much financial strength information do central banks need? by Claudio Borio* Head of Research and Policy Analysis Bank for International Settlements, Basel Presentation for Norges Bank Conference on “Banking Crisis Resolution – Theory and Policy” Oslo, 16-17 June 2005 Norway * The views expressed are those of the author and not those of the BIS

Introduction: CBs and crisis resolution 26.04.2017 Introduction: CBs and crisis resolution Information needs vary with role … CB is just one player in broader safety net roles do differ considerably … but one role in common: emergency liquidity assistance (ELA) 2

Three questions about ELA 26.04.2017 Three questions about ELA How do CB approaches differ? What are the implications for information needs? What are the key challenges/trade-off?

Highlight three points 26.04.2017 Highlight three points Absence of supervisory functions raises dilemmas for CBs in ELA Should pay more attention to ELA and market distress International issues loom large

Structure of remarks Why is question so relevant today? 26.04.2017 Structure of remarks Why is question so relevant today? Clarify the definition of ELA Examine the information needs for ELA to institutions ELA to markets Raise some issues about the international dimension

26.04.2017 Why ask now? Incipient trend towards loss of supervisory responsibilities CBs one step further removed from source of information Changing nature of liquidity demands from “bank runs” to “market runs” market distress can have systemic implications this has implications for information needs

Definition of ELA Economic literature: ELA to … 26.04.2017 Definition of ELA Economic literature: ELA to … D1: market as a whole (Thornton) D2: individual institutions (Bagehot) In practice it can be hard to draw the line between liquidity to the market and to individual institutions ELA and monetary policy implementation My definition: requires … … liquidity shortage that threatens or accompanies insolvency risks plus … operation outside normal conditions (terms/collateral) plus D1: no concern with possible failure of counterparty receiving funds D2: concern with possible failure of counterparty receiving ELA

ELA to institutions: 3 stylised types of CB 26.04.2017 ELA to institutions: 3 stylised types of CB Type 1 (“prudent micro-prudential”) ELA if and only if solvent but illiquid Type 2 (“prudent macro-prudential”) ELA like type 1 plus only if systemic risk Type 3 (“never say never”) ELA not ruled out if insolvent but systemic

ELA to institutions: information requirements 26.04.2017 ELA to institutions: information requirements Two kinds: financial strength of institutions (1 + 2) evaluation of systemic risk (2 + 3) Prudential information necessary (1 + 2 + 3) but not sufficient (for 2 + 3) system-wide distribution of exposures behavioural responses Need to combine prudential information with payment & settlement system and market functioning information  not easy!

ELA to institutions: choices of CBs without supervisory functions 26.04.2017 ELA to institutions: choices of CBs without supervisory functions Stylised choices: rely on supervisor’s information develop independent information Without necessary tools, (b) is hard Also raises interesting question What if the CB judgement differs from supervisor’s?  de facto loss of discretion

ELA to institutions: credibility issues 26.04.2017 ELA to institutions: credibility issues (1) and (2): credibility depends crucially on existence of alternative mechanisms to address systemic risk, without ELA (2): credibility depends on ability to resist likely political economy pressures issue of small versus large institutions

ELA to markets: what information? Case 1: clear that purely operational problems (eg. Y2K, 9/11) Lend freely/possibly cut interest rates need to go outside normal operational criteria depends on surplus collateral number and type of facilities number of counterparties eg. US vs euro area

ELA to markets: what information? Case 2: concerns about potential insolvency (eg. LTCM) Key questions need for more targeted action? does CB have sufficient knowledge/leverage/legal powers to act?  may require coordination with supervisors

ELA and the international dimension Two specific additional concerns one further step removed from information misalignment of incentives? eg. systemic in host but not at home Implications host CB in difficult position coordination desirable, how hard in practice?

Reference Borio, C (2004): “Market distress and vanishing liquidity: anatomy and policy options”, BIS Working Papers, no 158, July.