Bagehot's dictum: During a financial panic, the central bank should lend freely against good collateral to solvent firms at a penalty rate. The moral hazard ari

Bagehot's dictum: During a financial panic, the central bank should lend freely against good collateral to solvent firms at a penalty rate. The moral hazard arises because as the lender of last resort, the central bank is inevitably providing funds at a below market rate. This could encourage investment by those who can hope for a bailout and not face the full negative effects of the risk they've undertaken. However, so long as there's a penalty rate, this should control (if not completely overcome) the relevant moral hazard that might arise from the loans and (if you look at the system as a whole and the costs of the panic), the moral hazard is often worth enduring.