finance the deposit insurance. Alternative mechanisms through which the central bank could intervene are direct injection of equity into the system in the event of a liquidity crunch or engaging in a debt for equity swap. It could also lend through the discount window or other lending facilities, providing credit to distressed financial institutions on easier terms. Ashcraft, Garleanu, and Pedersen (2010) argue that controlling the credit supply through such lending facilities with low margin requirements is an important second monetary tool (in addition to the interest rate tool), which can raise asset prices, lower bond yields, and ease the funding problems in the financial system during crises. While there are such benefits of intervention, there is also costs. It is argued by many economists that if the central bank declares itself as a lender of last resort (LLR), this might result in a moral hazard problem, with the private sector becoming lax and this may even exacerbate the problem. Many economists therefore assert that the LLR must only be employed in extreme cases and must be a discretion of the government rather than a rule. Liquidity crisis in emerging markets It has been argued by some economists that financial liberalization and increased inflows of foreign capital, especially if short term, can aggravate illiquidity of banks and increase their vulnerability. In this context, 'International Illiquidity' refers to a situation in which a country's short-term financial obligations denominated in foreign/hard currency exceed the amount of foreign/hard currency that it can obtain on a short notice. Empirical evidence reveals that weak fundamentals alone cannot account for all foreign capital outflows, especially from emerging markets. Open economy extensions of the Diamond–Dybvig Model, where runs on domestic deposits interact with foreign creditor panics (depending on the maturity of the foreign debt and the possibility of international default), offer a plausible explanation for the financial crises that were observed in Mexico, East Asia, Russia etc. These models assert that international factors can play a particularly important role in increasing domestic financial vulnerability and likelihood of a liquidity crisis. The onset of capital outflows can have particularly destabilising consequences for emerging markets. Unlike the banks of advanced economies, which typically have a number of potential investors in the world capital markets, informational frictions imply that investors in emerging markets are 'fair weather friends'. Thus self – fulfilling panics akin to those observed during a bank run,