Pitfalls and Optimal Design of Emergency Liquidity Assistance

Schilling, Linda (2026): Pitfalls and Optimal Design of Emergency Liquidity Assistance.

Abstract

This paper studies why lender-of-last-resort support can fail to stop bank runs. In a nominal bank-run model with equity and multiple banks, I show that delayed Emergency Liquidity Assistance (ELA) shifts losses onto patient depositors and can trigger panic-driven withdrawals, even with sound assets and unlimited central-bank liquidity. The mechanism is a crisis-contingent, economy-wide inflation tax that insures early withdrawals while taxing those who stay, and redistributes resources across banks through the price level. The results highlight that ELA timing and fiscal design are critical for stability and can make regulatory interventions destabilizing rather than stabilizing.

• Item Type: MPRA Paper
• Language: English
• Keywords: Lender of Last Resort, Emergency Liquidity Assistance, financial regu- lation, bank runs, policy effectiveness, bank resolution
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E50 - General; G - Financial Economics > G3 - Corporate Finance and Governance; G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy ; Liquidation; G - Financial Economics > G3 - Corporate Finance and Governance > G38 - Government Policy and Regulation

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