A lender of last resort is an institution that is willing to offer loans as a last resort. Such an institution is usually a country’s central bank.
A central bank is the lender of last resort because, in any country, its central bank offers an extension of credit to financial institutions experiencing financial difficulty that cannot obtain necessary funds elsewhere.
The main task in front of the lender of last resort is to preserve the stability of the banking and financial system by protecting individuals’ deposited funds and preventing panic-ridden withdrawing from banks with temporarily limited liquidity. For more than a century and a half central banks have been trying to avoid great depressions by acting as lenders of last resort in times of financial crisis.
At first, this act provides liquidity at a penalty rate.
Subsequently, through open market operations, it lowers interest rates on safe assets. Finally, this process involves direct market support.
Commercial banks usually resort to lenders’ help only in tunes of crisis because such actions indicate financial difficulties. Loans may be granted to commercial banks and any other eligible financial institution, even private companies, considered highly risky.
Different institutions may act as a lender of last resort in different countries. For instance, in the USA, the Federal Reserve serves as a lender of last resort.
The main purpose is to provide credit to financial institutions short of reserves, prevent their bankruptcy, and avoid negative impacts on the economy.
As a lender of last resort, the Federal Reserve encourages member banks to borrow funds from the so-called “discount window” The term refers to loans granted to member banks.
The banks may use these loans to meet reserve requirements or pay for large withdrawals. In India, the State Bank of India serves as a lender of last resort.
In the United Kingdom, the Bank of England’s central bank functions as a lender of last resort. In New Zealand, the Reserve Bank of New Zealand, its central bank, takes this role.
On a global level, the International Monetary Fund also serves as an international monetary fund resort, taking such a role because of the recent financial crisis.
