Question

What is meant by the following function of the Central bank:

Lender of the last resort

With reference to the Central Bank, explain the following: 

Lender of the last resort

Explain the following function of the Central Bank:

Lender of the last resort.

Answer 1

If a commercial bank fails to meet its financial requirements from other sources, it can approach the Central Bank as a last resort for loans and advances. The Central Bank supports these banks by discounting approved securities and bills of exchange, or by providing loans against their securities. By providing temporary financial support, the Central Bank prevents the country’s financial system from collapsing. Direct lending to commercial banks is the lender-of-last-resort function of the Central Bank.

Answer 2

1. Preserving Confidence: A lender of last resort can give investors and depositors peace of mind that their money is safe, even during financial downturns. This can keep a problem from getting worse.
2. Preventing Contagion: By giving money to a bank that is having trouble, the central bank can stop ‘contagion,’ which is when problems at one bank can spread to other banks that are linked to it. This containment helps keep the effects of financial problems from spreading too far.