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Abstract
Traditionally, the main threat to financial stability has been the classic bank-run problem, in which a credit institution with a balance sheet principally composed of liquid liabilities and illiquid assets was forced to sell its assets at a deep discount because of a sudden call on its deposit liabilities. Because most of the bank’s liabilities were denominated in the local currency, the central bank could intervene to provide liquidity to the ailing institution. Bagehot’s law would apply, permitting the central bank to lend in an emergency only to banks that were illiquid but not insolvent, at a penal rate of interest, while taking the bank’s securities as good collateral.1 Systemic risk in the domestic economy could thus be controlled.
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