The Case for a Lender-of-Last-Resort Role for the IMF

The concept of a lender of last resort (LLR) stems from a central banking principle dating back to Bagehot more than a century ago. The principle holds that in a financial panic, the central bank should stand ready "to lend freely...whenever the security is good" (Bagehot 1873, 48, 51). This precept implies that in a financial crisis there is a multipleequilibrium situation, and that the good outcome can be secured and unnecessary real economic damage avoided by providing temporary liquidity to those entities that are fundamentally solvent. Application of the LLR concept to sovereign financial crises requires the judgment that the same principles apply when lending is cross-border and largely devoid of tangible collateral. This difference from domestic LLR lending underscores the importance of making the right judgment that the sovereign in question is politically willing and able, given enough time, to secure the resources that ensure it is solvent based solely on full faith and credit. In both the domestic and international contexts, a central assumption of LLR lending is that after confidence is restored, a reflow of private lending will materialize and the central bank (or IMF) will be repaid promptly. International experience suggests that this process can take much longer for sovereign cross-border crises than for domestic financial crises.