Managing a financial crisis: how legal constraints caused the institutional fragmentation of monetary power in Brazil during the post-2008 crisis

Abstract

The lender of last resort (LOLR) is an economic agent that has the economic capacity and is willing to provide liquidity when no other agent would. Resolution authorities are legally empowered to apply technical tools to deal with solvency crises. Unlike developed countries, where central banks created a wide range of emergency liquidity facilities and occasionally played the role of resolution authorities, the Brazilian Central Bank (BCB) was legally prevented from increasing its political actions due to the Fiscal Responsibility Law. This article argues that, due to legal constraints, the management of the 2008 crisis caused the institutional fragmentation of the monetary power in Brazil: the official functions of the BCB and the Deposit Insurance Fund (Fundo Garantidor de Créditos – FGC) were restructured. We define monetary power as the economic capacity, combined or not with the legal competence, to influence directly the creation of credit money in the economy. An analytical model is proposed to identify both the extension of the institutional rearrangement and its inherent institutional limits. It is possible to identify significant problems of economic efficiency as well as legitimacy gaps in the current fragmented legal framework. The legal design, mainly created by ad hoc rules of the Executive branch, seems unable to effectively respond to deeper financial crises in the future.

Brazilian Central Bank; Brazilian Deposit Insurance Fund; emergency liquidity assistance; lender of last resort; resolution regime; deposit insurance