What is the lender of last resort?

The lender of last resort (LOLR) is a role usually played by a country's central bank or a financial institution that offers emergency loans or liquidity support to financial institutions in distress to prevent a financial crisis.

The primary functions of the lender of last resort are: 1. Providing Emergency Loans: The LOLR provides emergency loans to financial institutions facing short-term liquidity issues to avoid bankruptcy or insolvency. These loans are typically provided at a higher interest rate than the market average. 2. Restoring Confidence: By providing emergency loans, the LOLR aims to restore confidence in the financial institution and the financial system as a whole. It assures market participants that the institution is solvent and can meet its obligations. 3. Preventing Bank Runs: A bank run occurs when a large number of depositors withdraw their funds simultaneously due to concerns regarding the institution's solvency. The LOLR helps to prevent bank runs by guaranteeing that the bank will have access to necessary liquidity to meet the withdrawal demands. 4. Stabilizing the Financial System: Providing necessary liquidity support to distressed institutions helps maintain overall financial stability and prevents a domino effect of institutional failures.

The lender of last resort plays a vital role in maintaining financial stability by: 1. Preventing Systemic Risk: The failure of one financial institution may lead to a ripple effect and cause other institutions to fail as well. By intervening timely, LOLR can prevent systemic risk and the associated economic downturn. 2. Protecting Consumers: LOLR steps in to prevent the failure of financial institutions, safeguarding the deposits and investments of consumers. 3. Ensuring Proper Functioning of Credit Market: By providing liquidity support to banks during a crisis, the lender of last resort ensures that the credit market continues to function properly, promoting economic growth. In summary, the lender of last resort is a crucial institution in maintaining financial stability, preventing bank failures, and restoring confidence during financial crises.