Lender of last resort

Central banks can create liquidity or "print money". This gives central banks a key role to play in the event of a financial crisis and they must therefore be prepared to provide such liquidity if a crisis should arise.

Norges Bank can supply extra liquidity to the banking system or individual banks in the event of liquidity problems. An extra supply of liquidity to the banking system may be appropriate when it is clear that the liquidity problems are only temporary and are not caused by more fundamental problems. If a large supply of liquidity is required, collateral requirements may differ from those laid down in the Regulation on banks' access to loans and deposits in Norges Bank etc. (the "Lending Regulation"), cf. Section 9.

Extraordinary liquidity for individual banks may be relevant if liquidity problems are limited to one or a few banks with more fundamental problems. Norges Bank may then extend loans on special terms (S-loans) to improve these banks' liquidity. The legal basis for making such loans is Section 19 of the Norges Bank Act.

The extraordinary liquidity that Norges Bank can provide may prevent problems from spreading and thus prevent a more serious crisis. However, banks' access to such liquidity support may also influence banking behaviour. If banks are confident that central bank funding will always be available, they may take greater risks than otherwise. Norges Bank therefore acts on the assumption that extraordinary liquidity should be reserved for situations where financial stability may be in jeopardy without such support.

Another important principle for providing extraordinary liquidity is that Norges Bank should not take on more credit risk than normal. The central bank is lender of last resort, as affirmed by the Storting after the 1990s banking crisis. In such situations, loans provided by Norges Bank should therefore be fully collateralised or guaranteed.

During the most recent financial crisis, Norges Bank provided S-loans to the Norwegian Banks' Guarantee Fund in connection with a short-term loan the guarantee fund made to Glitnir Bank ASA.

Published 20 October 2010 19:54
Edited 27 August 2012 13:57