When a systemic financial crisis occurs, the emergency lender's most crucial task is to restore confidence in the financial system... Speed is critical. Experience shows that the faster the lending, the lower the amount of lending necessary.3
To illustrate the benefits of acting quickly, I will use a canonical example, the Federal Reserve's operations in the aftermath of the stock market crash in October 1987. What is remarkable about this episode is that the Federal Reserve did not need to lend directly to the banks to encourage them to lend to the securities firms that needed funds to clear their customers' accounts. ecause the Federal Reserve acted promptly (within a day) and reassured banks that the financial system would not seize up, banks knew that lending to securities firms would be profitable. They saw that making these loans immediately was in their interest, even if they did not borrow from the Federal Reserve. anks thus began lending freely to securities firms, and, as a result, confidence was restored and the fear of crisis diminished almost immediately. The Federal Reserve did not have to increase its lending to the banking system at all, and the actual amount of liquidity that it injected into the banking system through open-market operations in the immediate aftermath of the crash was around $12 billion, which at the time was notable but not exceptional. And the Federal Reserve was able to remove this liquidity almost immediately, within weeks of the crash.