Central banks' liquidity provision can manage a liquidity crisis but cannot tackle the roots of liquidity risk, posits a new paper form the European Central Bank.

The research finds that central banks can minimise the probability of a financial meltdown in turbulent periods. But central banks cannot distinguish between illiquid and insolvent banks with certainty and by providing liquidity to undeserving institutions it could potentially cause damage to the system.

The research concludes that