Business, Legal & Accounting Glossary
A lender of last resort is a financial institution, such as a nation’s central bank, that provides economic relief by bankrolling failing financial infrastructures.
A lender of last resort does so by making loans to banks and other qualified institutions. The purpose of the lender of last resort is to alleviate a situation in which banks face immense withdrawals caused by panic and fear of the unknown. As such, the lender of last resort offers protection to individuals and provides an economic boost to banks at times of grave financial instability. In the United States, the Federal Reserve acts as the lender of last resort. Conditions that call for functions of the lender of last resort can arise from any economically destabilizing occurrences. Thus, a lender of last resort may step in times of war, natural disasters, economic depression, etc.
Lender of last resort is an institution, which offers loans to commercial banks (or other concerned institutions) in dire straits and in need of a bailout. Usually, central banks act as the lender of last resort in a country’s financial system. In the USA, The Federal Reserve is a lender of last resort to institutions, which are left with no other borrowing sources and whose failure to honour financial obligations may have far-reaching consequences on the economy at large. Lender of last resort protects the interests of individual investors who have deposited in funds. It also helps to prevent panic cash withdrawal from banks with temporarily limited liquidity. Commercial banks in principle avoid borrowing from a designated lender of last resort as it signals that the bank concerned is in midst of a financial crisis. Critics of lender-of-last-resort system opine that this system inadvertently tempts risky deals since commercial banks are somewhat sheltered from the true level of accruing risks.
In view of various global crises, a section of the global intelligentsia has put forward a case for the role of the International Monetary Fund (IMF) as an international lender of last resort. It may be noted at this stage that IMF unlike central banks of countries does not possess the power of printing money. Countries like Argentina, Turkey, Brazil, Thailand, Indonesia, Russia, Korea and Mexico have been recipients of emergency lending in large volumes from IMF at various points of time. The total volume of IMF lending to above-mentioned eight nations increased from SDR 8.4 billion at the 1994-year end to around SDR 22 billion in period 1995–96. This lending volume hiked to SDR 48 billion at the 1998-year end at the time of the east-Asian crisis. At the 2003-year end, this figure stood at SDR 56 billion. However, there have also been phases of low emergency loan figures for IMF. The bottom line for the sustainability of this policy is timely repayment of dues by nations. However, nations are often offered repayment periods, which run into years instead of days, or months as common in the standard banking system.
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This glossary post was last updated: 27th March, 2020