It is also important that the central bank, even if it does not have direct supervisory responsibilities, closely monitors general financial market developments, including in the major institutions, to detect potential crisis situations that may call for ELA. The traditional view that ELA should never be given to insolvent banks can also be discussed from another perspective. A prerequisite for all kinds of support, including ELA, should be that there is considerable risk for a systemic crisis. Given that, it can be discussed whether it is worse to provide ELA to an insolvent institution, or to refrain from an action that could avoid a systemic crisis. If there is a risk of systemic crisis, it is normally determined that public support even to insolvent institutions may be warranted, but this is normally given by the government through the fiscal budget, not by the central bank. The moral hazard aspects, which are common arguments for not providing ELA to insolvent institutions, will be no different if the central bank provides support or if the government does. The central bank may have a better capability than other authorities to provide financial support if the need arises very quickly. The main reason for this is that the central bank has the instruments for lending available and it has resources in its balance sheet or the credibility to get resources if they are needed (for example in foreign currency).
The way other crisis management procedures are set up also affects the scope for ELA. This is covered in the first part of this note. Second, the way ELA issues are organised within the central bank is also very important for whether it is an effective measure and, in particular, whether it will reduce or increase moral hazard in the financial sector. This is discussed in the second part of the note. Before discussing these two aspects, the importance of speed in granting ELA must be emphasized, as the speedy implementation of ELA is essential to its being effective in a crisis situation. ELA is the only measure in the crisis management framework that normally can be used quickly. It should be seen as an acute measure that is used for avoiding a sudden disruption of the large-value payment system, in particular when threats to the system emerge suddenly. Incidents like the failure of Barings bank, LTCM and the Swedish currency and banking crisis show that threats to the financial system may indeed emerge suddenly, and that authorities must react very quickly - if not within minutes, at least within hours. The growth and increasing globalisation of financial markets, the high volatility in these markets and the increasing complexity of financial institutions, are all examples of factors that increase the risk for sudden crises and increase the probability that such crises will spread from one market to another. 1.