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Prepared by Mario Dehesa and Pablo Druck.
In many developing countries additional requirements are needed to reduce moral hazard and protect the LOLR from undue political pressure, including well designed lending procedures, clearly laid out authority and accountability (He, 2000).
In practice the ECCB backing ratio expanded from around 83 percent in 1983 to fluctuate at over 95 percent since 1995. Despite the quasi-currency board arrangement, the ECCB is permitted to provide credit to its members under specified limits and within the reserve cover requirement (IMF, 2004).
In the early 2000s, out of a group of six modern currency board arrangements (CBAs), only Bosnia and Herzegovina explicitly ruled out a LOLR facility. Hong Kong, Argentina and Bulgaria had provisions that explicitly collateralized emergency lending, up to the excess foreign reserves available. Estonia and Lithuania had no formal provisions, but may provide support on a case by case basis (Ho, 2002).
Article 24 of the ECCB Act does not specify if the external reserve to cover demand liabilities refers to a gross or net concept. To compute the backing ratio, some CBAs like Bulgaria and Lithuania use a gross concept of foreign assets that does not take into account the central bank’s long-term external obligations coming, for instance, from the IMF and/or the World Bank.
The model assumes a fixed exchange rate regime, and therefore the liquidity assistance reduces international reserves, and raises the devaluation risk; total liquidity is measured by xt = x1 + x2.