Question

How does the central bank act as a lender as the last resort?

Explain the function of the Central Bank (The Reserve Bank of India) as a lender of the last resort.

Why is the central bank referred to as the “lender of the last resort”?

With reference to the Central Bank, explain the following:

Lender of the last resort

What role does RBI play as the ‘lender of the last resort’?

Answer 1

1. As a banker to the banks, the central bank (The Reserve Bank of India) acts as the lender of last resort. In case the commercial banks fail to meet their financial requirements from other sources, they can, as a last resort, approach the central bank for loans.
2. The central bank gives loans to such banks through discounting of approved securities and bills of exchange.

Answer 2

The central bank also functions as a lender of last resort. According to De Kock, this is an essential and indispensable role of the central bank, given that it is the custodian of cash reserves of the commercial banks.

When commercial banks have exhausted their resources and are in need of funds, they turn to the central bank as a last resort during financial emergencies to help them overcome their crises. As the lender of last resort, the central bank offers reasonable financial assistance, either directly or indirectly, to commercial banks, discount houses, bill brokers, and other financial institutions.

The central bank provides this support during times of financial stress by discounting approved securities and granting collateral-based loans and advances. In doing so, the central bank prevents the collapse of the country’s financial system by offering temporary financial accommodation.