Demand deposits and other short-term bank liabilities are safe, easy-to-value claims that are well suited for transaction purposes and provide money-like benefits to firms and households.5 Second, in a world without LOLR, shortages of liquid assets would be exacerbated during stress episodes. Banks would likely hoard their liquidity buffers.
Knowing they must rely only on their own liquidity to meet demands even as market uncertainty is increasing and asset values suffer downward pressure, banks would have to reduce dramatically their core intermediation function. They would be reluctant to lend to firms and households that are themselves subject to the impact of the systemwide liquidity shocks.