Banking Crises and the Lender of Last Resort: How Crucial is the Role of Information?

This article develops a model of bank runs and crises and analyses how the presence of a lender of last resort (LOLR) affects the solvency of the banking system. We obtain a one to one mapping from the depositors' equilibrium strategy to an optimal contract prevailing in the economy. The study finds that the difference between a perfectly informed and an imperfectly informed LOLR can be crucial. Our results indicate that a perfectly informed LOLR is a Pareto improvement. However, if the supervisory process of the LOLR is subject to noise, then the gains from ex post efficiency may be outweighed by ex ante inefficiency induced by moral hazard which is conducive to lower lending rates in the economy.