Lender of last resort
A central bank can "create liquidity" or "print money". It will therefore be able to play a key role in financial crises, and must have a contingency plan in case any such situation should arise.
Because it can create liquidity, the central bank can contribute to preventing problems from spreading, and thereby prevent a major crisis. But the possibility of receiving liquidity support may also influence the behaviour of banks. If banks believe they will always be able to borrow from the central bank, they will take greater risks than they would otherwise have done. Norges Bank has established the principle that extraordinary provision of liquidity shall be restricted to situations where financial stability may be threatened if such support is not provided.
Another important principle concerning the supply of liquidity is that Norges Bank shall not provide solvency support. This principle was established after the last banking crisis. In such situations, Norges Bank's loans should therefore be extended against provision of full collateral or guarantees.
Norges Bank adopted new guidelines for extraordinary provision of liquidity in March 2004. See "Norges Bank's role in the event of liquidity crises in the financial sector" in Financial Stability 2/2004
For an overview of how the role of the lender of last resort is viewed has changed over time, see: Norges Bank's role in the event of liquidity crises in the financial sector by Karsten Gerdrup.
Banks and other financial institutions are increasingly establishing themselves outside their home countries. This implies a spreading of risk, but also implies a challenge for the authorities who have to handle any crises. The central banks of the Nordic countries have signed an agreement as to how a crisis in a bank that is established in two or more of the countries is to be handled.
There are also similar agreements within the EU. An overview of the challenge presented to the authorities by cross-border banks is given in: