Abstract
Starting with the 2007-09 financial crisis and continuing through the coronavirus (COVID-19) pandemic, financial markets faced a series of severely adverse shocks. In response, central banks scrambled to update their policy toolkits. To ensure financial stability, safeguard the monetary policy transmission mechanism, and guarantee the continued flow of credit to the real economy, they expanded their lending operations to restore funding liquidity and intervened in financial markets directly, purchasing securities to restore market liquidity. After all, without well-functioning financial markets and a stable financial system, policymakers would never be able to meet their price stability or dual mandate. In their traditional lending operations, central banks make loans to banks and other intermediaries against a limited set of high-quality collateral. Today, a much wider range of collateral is accepted in enhanced lending operations directed at ensuring credit flows to non-bank financial institutions (NBFIs) and non-financial firms. Furthermore, the experience following the 2007-09 financial crisis shows that central banks' enhanced lending to impaired market makers has often succeeded in restoring their market making capacity, obviating the need for direct purchases. Advanced economy central banks are now less hesitant to intervene directly in markets, purchasing both government and privately issued securities in an effort to stabilise financial markets they view as systemic. At least initially, policymakers considered such policies to be extraordinary measures for extraordinary circumstances. However, as policymakers intervened massively during the 2007-09 financial crisis and in the early stages of the COVID-19 pandemic, markets are likely to expect policymakers to use these instruments again if faced with similar circumstances. This report begins with the observation that central banks are now extensively employing enhanced lender of last resort (LOLR) and market maker of last resort (MMLR) facilities, often putting them in place quickly and in a manner that leaves little time to reflect on their structure. With that in mind, we take a step back and examine how authorities that feel compelled to use them again might design enhanced LOLR and MMLR facilities to maximise their effectiveness while minimising the damage that they might cause.