There was no system for conducting system-wide stress tests for determining the appropriate level of bank capital, and micro-prudential capital requirements were inadequate, so banks tended to be undercapitalised. And there was no regime for resolving insolvent firms in an orderly way. This placed the Bank of England in a difficult position. In particular, there was a heightened risk that LOLR for a particular bank would turn out to be solvency support, with no credible exit strategy. In response, the Bank adopted a conservative approach to providing liquidity  1  2  See for instance “The Development of the Bank of England’s Market Operations”, October 2008 (http://www.bankofengland.co.uk/markets/Documents/money/publications/condococt08.pdf); “Extending eligible collateral in the Discount Window Facility”, March 2010 (http://www.bankofengland.co.uk/markets/Documents/money/publications/condocmar10.pdf); the “Review of the Bank of England’s framework for providing liquidity to the banking system” by Bill Winters (http://www.bankofengland.co.uk/publications/Documents/news/2012/cr2winters.pdf) and the “Review of the Bank of England’s provision of Emergency Liquidity Assistance in 2008-09” by Ian Plenderleith, (http://www.bankofengland.co.uk/publications/Documents/news/2012/cr1plenderleith.pdf), both October 2012; and the Bank’s response (http://www.bankofengland.co.uk/publications/Documents/news/2013/ nr051_courtreviews.pdf and http://www.bankofengland.co.uk/markets/Documents/money/publications/ liquidityinsurance.pdf). BIS central bankers’ speeches  assistance in the early stages of the financial crisis. Ironically, therefore, concerns about the risks of lending “too much” led to perceptions the Bank would lend “too little”. Post-crisis reforms have changed this situation significantly. Banks are now subject to heightened liquidity and capital regulation, and annual stress testing. And the UK has a statutory resolution regime.

4  BIS central bankers’ speeches  appropriate boundaries for covert action. At the same time, the consequences of premature disclosure were vividly illustrated by the case of Northern Rock in September 2007, when a press leak led to long queues at branches, and required the government to issue a blanket guarantee to ease public concern. Where liquidity shortages are widespread, or central bank support would otherwise be seen as clearly confidence-enhancing, there are strong advantages in central banks conducting overt operations. But the capacity to operate covertly, subject to accountability safeguards, remains an essential part of the central bank toolkit. The final UK lesson is that LOLR frameworks must be flexible enough to respond to changes in the structure of financial markets if societies are to guard against the twin perils of lending “too little” or “too much”. At the start of the crisis, the UK’s LOLR toolkit was poorly equipped to deal with the needs that emerged, and had to be innovated rapidly. The changes introduced in recent years have reduced the risk that the Bank would lend “too little” if the same risks re-occurred. In all probability, however, the next crisis will not be like the last one. It is important that policy steps taken to prevent central banks lending “too much” to today’s financial institutions do not also impair their ability to maintain financial stability as the structure of financial markets adjust and policy needs change. One important change is the shift from bank to market-based finance.