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Reflection on the Role of Central Bank in Resolving Banking Crisis

Reflection on the Role of Central Bank in Resolving Banking Crisis. Bank of Israel. Rony Hizkiyahu. European Banking & Financial Forum 2008 Prague, April 1-3. Causes of banking crisis or individual bank failure. Macro factors

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Reflection on the Role of Central Bank in Resolving Banking Crisis

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  1. Reflection on the Role of Central Bank in Resolving Banking Crisis Bank of Israel Rony Hizkiyahu European Banking & Financial Forum 2008 Prague, April 1-3

  2. Causes of banking crisis or individual bank failure • Macro factors Economic recession, Financial deregulation, Unsound supervisory system, Political issues • Non-macro factors Unsound banking practices, Inappropriate risk management – liquidity risk, Lack of corporate governance, Embezzlement

  3. Resolution of Crisis The lesson of Walter Bagehot (1873) is still applicable: in crisis lender of last resort should lend freely, at a penalty rate, on the basis of collateral that is marketable in the ordinary course of business when there is no panic.

  4. High-Level Principles for Lender of Last Resort • Time is crucial. • Lender of last resort should lend to illiquid but not to insolvent institutions. • Lending only against collateral. • Lending at a penalty rate. • Lending is contingent with a recovery plan • Lending to the markets or lending to individual institutions? Mitigate moral hazard

  5. Improvements Proceeding Banking Crisis or Failure • Introduction of safe and sound banking practices. • Prompt corrective action. • Raising deposit insurance premium and/or adopting differential premium system. • Improved resolution method.

  6. The Israeli Case • No major bank failures in the last 30 years. • No sub-prime mortgage market. • No systemic house price bubble. • Limited exposure to MBS. • No de jure deposit insurance. • The Bank of Israel established teams to improve prevention and resolution of crises.

  7. Thank you

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