Central Bank of Chile as lender of last resort
| Autor | Gonzalo J. Arias A. |
| Cargo | Master of Laws, The University of Melbourne, Australia Lecturer, Law of Regulation, Universidad Mayor, Chile |
| Páginas | 119-154 |
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CENTRAL BANK OF CHILE AS LENDER OF LAST
RESORT
Proposal for the Conditions of the Emergency Loan
Gonzalo J Arias A
Master of Laws, The University of Melbourne, Australia
Lecturer, Law of Regulation, Universidad Mayor, Chile
Gonzalo.ariasa@mayor.cl
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ABSTRACT
By contrasting the four pillars of Bagehot´s classical theory of the Lender of Last Resort
with the Basic Constitutional Act of the Central Bank of Chile (CB), the conditions of the
loan are proposed. The emergency loan should have penalty rate that avoids the moral
hazard of taking the risk of becoming illiquid and having the CB as a Lender of Last
Resort. It is also proposed that this penalty rate could be determined by the application
of the law 18.010, or by the application of a penalty tax with a fixed rate of 25.5% or 27%
or with a progressive penalty rate. In both cases, the paid tax cannot be deducted as a
credit against other taxes. A third alternative is presented: apply the same interest rate
of the IMF. Finally, private banks cannot transfer the charged interest to the creditors.
Regarding the good collateral, the proposal is to require a long-term security classified
by a credit rating agency with AAA, AA o A. This is because they represent the higher
capacity to pay the guaranteed capital and interested and are less affected, deteriorated
or delayed for possible changes in the issuer, the industry to it belongs or the economy.
Finally, an amendment to article 36.1 of the Basic Constitutional Act of the Central Bank
of Chile is presented.
Keywords: Financial stability – lender of last resort – Central Bank
RESUMEN
Al contrastar los 4 pilares de la teoría clásica de Bagehot sobre el préstamo de última
proponen las condiciones del préstamo. El préstamo de emergencia debe tener tasa-
sanción para que se evite el riesgo moral de tomar el riesgo de perder liquidez y tener el
CB como un prestamista de última instancia. También se propone que este tipo de
sanción podría ser determinado por la aplicación de la ley 18.010, o por la aplicación de
un impuesto de multa con una tasa fija del 22,5% o con una tasa de penalidad
progresiva. En ambos casos, el impuesto pagado no puede ser deducido como crédito
contra otros impuestos. Se presenta una tercera alternativa: aplicar el mismo tipo de
interés del FMI. Finalmente, los bancos privados no pueden transferir el interés que se
cobra a los acreedores. En cuanto a la garantía, la propuesta es exigir títulos a largo
plazo clasificados por una agencia de calificación crediticia como AAA, AA o A, ya que
representan la más alta capacidad de pago del capital e interés y son menos afectados,
deteriorados o menos afectados por posibles cambios en el emisor o la industria a que
pertenece o en la economía en general. Finalmente, se presenta la propuesta de
modificación del artículo 36 inciso primero de la Ley Orgánica Constitucional de Banco
Central.
Palabras claves: Estabilidad financiera – prestamista de última instancia – Banco Central
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1. INTRODUCTION
This research paper proposes the conditions that the Central Bank of Chile (CB) should require
to private banks when granting an emergency loan in the exercise of the attribute of Lender of
Last Resort (LoLR). Article 36 of the Basic Constitutional Act of the Central Bank of Chile will be
analysed in detail the. The article expresses that to safeguard the stability of the financial system,
the Bank is entitled to grant loans to banks and finance companies in case of emergency for a
period not exceeding 90 days when they present problems stemming from a temporary lack of
liquidity.
This regulation mentioned above establishes the institution of the Lender of Last Resort in the
Chilean jurisdiction. However, given the fact that the statute is broadly open, complex and with
no specification in detail, it can undermine the performance of the CB in case of financial
instability like bank runs or other major events.
That is why, in absence of specific regulations that determine the unique conditions of the loan,
a detailed proposal will be presented of how to avoid possible loopholes in case a new financial
crisis arises.
The structure of this paper is divided into three chapters. The first chapter analyses financial
stability and liquidity in financial markets to understand the relationship between them and
financial crisis; that is, how the former may cause the latter. Then, the Global Financial Crisis
(GFC) of 2008 and the role of CB in financial stability will be briefly addressed. The essay will
address that one the CB role is to oversee the stability of financial markets by exercising the
attribution of the Lender of Last Resort. This attribution will be explained in detail (from
Bagehot´s classic theory and its four pillars), in order to demonstrate how the Federal Reserve
and the Bank of England were forced to deviate from the traditional approach to avoid further
consequences of the 2008 GFC.
The first chapter is designed to have a comprehensive understanding of the impact of financial
crisis in developed financial markets like the US and the UK, and to explain how the absence of
pre-established rules for the LoLR forced regulators to depart from Bagehot´s principles.
The second chapter of this paper addresses, on the basis of international experience, how
different financial crises, like the ones in 1982, 1998 and 2008, have affected and had an impact
on the regulations of the LoLR in Chile. It will be then explained the regulation of financial
stability in Chile through different pieces of legislation.
By contrasting the four pillars of the classic theory with the Basic Constitutional Act of the
Central Bank of Chile, the conditions of the loan are proposed: there is no doubt that the
emergency loan is applicable only to an illiquid, but solvent, bank. Furthermore, the emergency
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