Research Discussion Paper – RDP 2001-07 A History of Last-resort Lending and Other Support for Troubled Financial Institutions in Australia
October 2001
Abstract
This paper surveys the history of last-resort lending and other support provided to financial institutions in Australia and compares the practical implementation of lender-of-last-resort policy with policy prescriptions derived from the theoretical literature. Last-resort support serves to counter the market failures that can see fundamentally sound financial institutions fail due to a lack of liquidity, and to protect the economy from the systemic costs of such failures. The provision of lender-of-last-resort support, however, creates moral hazard costs.
During the nineteenth century, Australian colonial governments and banking industry groups provided support to troubled financial institutions in a variety of ways that reflected both the resources they could draw on and their ability to constrain moral hazard behaviour. Since 1900, Australia's experience has been unusual by international standards: the central bank has rarely acted as a lender of last resort; and, despite this, virtually no Australian bank depositor has lost money. Direct loans were provided only twice: once as a last-resort loan and once to ease the exit of a failed bank. Instead, support has come in more indirect forms. Loans were provided to three banks in support of their efforts to provide funds to illiquid building societies. Most instances of disruptions to financial institutions' access to liquidity, however, have been successfully staunched by the central bank's issuance of reassuring public statements.