[tspareme]

I guess you have to define what a solvent bank is. I don't think any bank can handle a sustained run given their liability duration mismatch. So I am not sure what do you mean that you can't create a panic. Its always possible to have runs just not very easily.

The financial crisis showed that bank liabilities are really liabilities of the country that the bank incorporates in. So in case of Ireland, Greece, Iceland, it is up to the country to step up and backstop their banks. If a country can not, then you will have panic on a bank. And in order for a country to be able to backstop their banks, the debt of the country must be credible.

[notahacker]

I'd argue a solvent bank is one whose expected return on assets, adjusted for expected losses, is sufficient to ensure it can repay money lent to it at the discount window rate [for all plausible trajectories of the base interest rate over the lifetime of its outstanding assets]

There's no logical reason why a central bank wouldn't lend to such a bank at the discount window even if some irrational hysteria caused its depositors to withdraw en masse, or why another bank not suffering from depositor hysteria wouldn't buy its loan portfolio.

The problem of national governments' economic policy lacking credibility is largely orthogonal[1]; central banks that underwrite private banks print money rather than borrowing it

[1]except to the extent really inept inflation-boosting fiscal policies compel the central bank to make aggressive and unanticipated interest rate rises that drive banks into insolvency.

[tspareme]

The issue is expected loss. No one knew what is the expected loss in a crisis. This is why some of the Lehman debt holders actually made money from the bankruptcy. This is why TARP actually made money. It is because there is a substantial difference in asset price while in crisis and not in crisis. The asset price is what is making the bank solvent.

Of course, the central bank (unless you are locked into a monetary union of course) can lend freely during a crisis. However, it must also be careful as to not trigger inflation or worse yet cause people to lose faith with your currency. There is also moral hazard as well but that's more of a soft issue.

The bigger issue is what happens if your bank liability is many times larger than your countries GDP. This was the case with Iceland or Britain. Then you can't print enough money to make your bank whole.