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CHAPTER 17
Tools of Monetary Policy
457
This mechanism is designed to increase the supply
of high-quality securities that could be used for collateral by banks. It can also be
used to swap less-liquid securities for more-liquid securities that the banks are
putting up as collateral. It is also designed to partially offset the temporary increase
in assets in the Bank s books associated with the term purchase and resale transactions.
TERM SECURITIES LENDING
Advantages
and Disadvantages of the
Bank s Lending
Policy
Although the Bank of Canada s role as the lender of last resort has the benefit of
preventing bank and financial panics, it does have a cost. If a bank expects that
the Bank of Canada will provide it with advances when it gets into trouble, it will
be willing to take on more risk knowing that the Bank of Canada will come to the
rescue. The Bank of Canada s lender-of-last-resort role has thus created a moral
hazard problem similar to the one created by deposit insurance (discussed in
Chapter 11). Banks take on more risk, thus exposing the deposit insurance agency,
and hence taxpayers, to greater losses. The moral hazard problem is most severe
for large banks, which may believe that the Bank of Canada and the CDIC view
them as too big to fail ; that is, they will always receive Bank of Canada emergency lending assistance when they are in trouble because their failure would be
likely to precipitate a bank panic.
Similarly, Bank of Canada actions to prevent financial panic may encourage