But another strand in the debate draws the opposite conclusion from the crisis – focusing on the risk that central banks might lend “too little”, too rarely or too late, amplifying what might begin as short-term liquidity shortages into deeper or more persistent solvency concerns, and subsequently causing financial institutions to over-insure, reducing their capacity to lend. The main policy conclusion from this way of thinking is that central banks need stronger toolkits for detecting and responding to liquidity crises. These (deliberately stylised) perspectives seem diametrically opposed. National debates have tended to lean one way or the other, depending on each country’s specific crisis experiences. But, in truth, it is vital we pay heed to both. Without an effective LOLR framework, economies cannot hope to foster strong and sustainable growth over the long run. History shows that, sooner or later that growth, and the employment it supports, will be threatened by an unexpected withdrawal of liquidity from key parts of the financial system, unconnected to the underlying quality of real assets in the economy. Historically that liquidity risk resided primarily in the banking sector. But as economies migrate towards more market-based forms of finance, liquidity risk is increasingly likely to originate (or be concentrated) elsewhere: including broker-dealers, central counterparties (CCPs), or traded instruments themselves. The herd mentality that can develop during crises can sometimes only be tamed by well-designed intervention – be it covert or overt – using a credible backstop. Countries lacking such backstops are likely to sustain large-scale, and preventable, economic damage.

Taken together, these steps mean that LOLR no longer has to shoulder as much of the burden of preventing insolvency ex ante, or dealing with it ex post. As such, the Bank is now able to state, as a presumption, that all banks and building societies meeting the supervisory threshold conditions for authorisation may sign up for, and access, the Bank’s published liquidity facilities 2. So changes designed to reduce the risks of lending “too much” have actually allowed the UK to offer a more effective LOLR scheme. The second lesson drawn in the UK was that, to avoid the twin pitfalls of “too little” and “too much”, the central bank should have access to the best possible information to judge solvency; and wherever possible be ready and willing to lend on pre-defined terms, against pre-defined collateral. Prior to the crisis, the Bank said very little about the terms on which it would be willing to provide LOLR, or the collateral against which it would lend. Indeed the provision of liquidity insurance wasn’t explicitly acknowledged in its public framework, in large part with a view to minimising moral hazard. In addition, the Bank had limited access to information on the financial position of firms to whom it might have to provide LOLR, because banking supervision was carried out in the Financial Services Authority, a separate organisation. In practice, efforts to tackle moral hazard had little effect: in the absence of formal regulatory requirements, banks took minimal steps to self-insure against liquidity risk.