Optimal Lender of Last Resort Policy in Different Financial Systems

In a framework closely related to Diamond and Rajan (2001) we characterize different financial systems and analyze the welfare implications of different LOLR-policies in these financial systems. We show that in a bank-dominated financial system it is less likely that a LOLR-policy that follows the Bagehot rules is preferable. In financial systems with rather illiquid assets a discretionary individual liquidity assistance might be welfare improving, while in market-based financial systems, with rather liquid assets in the banks balance sheets, emergency liquidity assistance provided freely to the market at a penalty rate is likely to be effcient. Thus, a 'one size fits all'- approach that does not take the dfferences of financial systems into account is misguiding.