Interventions in Markets with Adverse Selection: Implications for Discount Window Stigma

Abstract

I study the implications for central bank discount window stigma of a workhorse model of adverse selection in financial markets. In the model, firms (banks) need to borrow to finance a productive project. There is limited liability and firms have private information about their ability to repay their debts, which gives rise to the possibility of adverse selection. The central bank can ameliorate the impact of adverse selection by lending to firms. Discount window borrowing is observable and it may be taken as a signal of firms' credit worthiness. Under some conditions, firms borrowing from the discount window may pay higher interest rates to borrow in the market, a phenomenon often associated with the presence of stigma. I discuss these and other outcomes in detail and what they suggest about the relevance of stigma as an empirical phenomenon.

Can Discount Window Stigma Be Cured? An Experimental Investigation

“…Empirical evidence of stigma associated with backstop facilities like the DW has been provided by Peristiani (1998), Furfine (2001), Armantier et al (2015, Anbil (2018), Vossmeyer (2019), Anbil and Vossmeyer (2019), Beyhaghi and Gerlach (2023), and Armantier and Cipriani (2024). Formal models of emergency lending with stigma have been proposed by Ennis and Weinberg (2013), La'O (2014), Ennis (2019), Gorton and Ordonez (2020), Hu andZhang (2023), andChe et al (2023). To the best of our knowledge, A&H and the present paper are the only studies that focus on anti-stigma policies.…”

Supply and Demand Effects of Bank Bailouts: Depositors Need Not Apply and Need Not Run

“…This is because bailouts may stigmatize the recipients, creating doubt about their financial health. Depositors and other market participants may also recognize that the bailouts increase moral hazard incentives of the banks, leading market participants to exert more discipline on these banks (e.g., Philippon and Skreta 2012, Tirole 2012, Armantier et al 2015, Ennis 2019, Che, Choe, and Rhee 2020. Excessive market discipline may also have unfavorable social consequences in terms of substantially reduced confidence in the financial system and curtailments in the supply of credit to reduce risk that may hamper economic growth.…”

The Fed's Discount Window in "Normal" Times

“…See, for example,Klee (2019),Ennis and Weinberg (2013),Armantier et al (2015),Gauthier et al (2015),Ennis (2019),Ennis and Price (2020), and the citations therein.3 The role of the discount window during crises has been more extensively studied in recent years. For example,Berger et al (2017),Gauthier et al (2015),Li, Milne, and Qiu (2020),Gilbert et al (2012), and Gerlach and Beyhaghi (2020) study empirically discount window lending in the U.S. during the financial crisis Klee (2019).…”