What is a Lender Of Last Resort?

A lender of last resort (LOLR) is the institution that gives loans to institutions that are experiencing a lack of liquidity or an institution that guarantees liquidity or credit to financial institutions, the institution offers loans as a last resort. It is one of the main responsibilities of the central bank of any country. In some countries like the United States, the central bank which is the Federal Reserve Bank is the lender of last resort so as to prevent economic disruption when the alternatives of the financial institutions have been exhausted.

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How Does a Lender Of Last Resort Work?

Commercial banks usually avoid resorting to the central banks because this is an indication that they are in financial difficulties. The banks are provided with credit by the central bank in order to guarantee that customers confidence is retained and thereby prevent customers from withdrawing out of panic which can subsequently lead to the collapse of the financial institutions or systems. The credit provided is to provide liquidity to the banks to run their operations temporarily. One major criticism of the lender-of-last-resort concept is that financial institutions because of the availability of the lender of last resort facility may make the institutions to take a more unnecessary risk as there will be a way out if they fail

Lender Of Last Resort and Preventing Bank Runs

A bank run is when customers panic and withdraw all their deposits from the banks in large numbers within a short time frame. This occurrence may exhaust the banks liquidity since banks are required to keep only a small percentage of their total deposits thereby resulting in the insolvency of the bank. The Great Depression of 1929 which was a result of the collapse of the United States stock market led to bank runs which resulted in the failure of a lot of banks. This led the US government through the Federal Reserve to make some laws that require the bank to maintain a reserve ratio in the Federal Reserve Bank. There are circumstances where the banks reserve will not be enough for the bank run, the central bank can come in, in those circumstances to provide liquidity to avoid panicking by the public so as to prevent economic disruption and ensure the stability of the financial system

Criticisms of Lender Of Last Resort

Opponents of the central bank acting as lender of last resort are of the opinion that banks are likely to take more risk that is not needful since they are aware that there is a bailout. Proponents are of the view that the risk of not having a last resort lender far more outweighs the resultant reckless by banks. The claims by the opponents were confirmed in the global financial crisis of 2007/2008

Related Topics

• Legal Tender
• Numismatics
• Gresham's Law
• Barter
• Double Coincidence of Wants
• Parity
• Functions of Money
• Medium of Exchange
• Unit of Account
• Store of Value
• Time Value of Money
• Standard of Deferred Payment
• Liquidity Preference Theory
• National Savings and Investment Identity
• Circular Flow of Money
• Commodity Money
• Gold Exchange Standard
• Bretton Woods System
• Fiat Money
• Money Supply
• M1 and M2 Money Supply
• Monetary Base
• Savings, Demand, and Time Deposits
• Banks
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• Financial Intermediary
• Bank Balance Sheet
• Money Multiplier Formula
• Velocity of Money
• Multiplier Effect
• Quantity Equation of Money
• McCallum Rule
• Neutrality of Money
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• Central Bank
• Federal Reserve System
• Federal Open Market Committee (FOMC)
• Fed Balance Sheet
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• Taylor Rule
• How is the Federal Reserve Bank Organized?
• What is Bank Regulation?
• CAMELS Rating
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• CFPB
• Bank Supervision
• Bank Runs
• What is Deposit Insurance?
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• Central Banks Carry Out Monetary Policy
• Open Market Operations
• Bank Reserve
• Discount Rate
• Federal Funds Rate
• Monetary Policy
• Contractionary and Expansionary Monetary Policy
• Loose vs Tight Monetary Policy
• Easy Monetary Policy 
• Accommodative Monetary Policy
• Dove & Hawk (Monetary Policy) - Explained
• Tight Monetary Policy - Explained
• Stabilization Policy
• Pushing on a String
• The Effect of Monetary Policy on Interest Rates
• Federal Funds Rate
• Gibson Paradox
• Vasicek Interest Rate Model
• Equation of Exchange (Economics)
• The Effect of Monetary Policy on Aggregate Demand
• Quantitative Easing
• Reserve Currency
• What are Excess Reserves?
• Unpredictable Movements of Velocity
• Central Banks - Unemployment and Inflation
• Inflation Targeting
• Fisher Effect
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• Countercyclical
• Money Capital Market
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• Aggregate Expenditure Model
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