What Is Lender of Last Resort?

A lender of last resort (LoR) is an institution, usually a country's central bank, that offers loans to banks or other eligible institutions that are experiencing financial difficulty or are considered highly risky or near collapse. In the United States, the 澳洲幸运5官方开奖结果体彩网:Federal Reserve acts as the lender of last resort to institutions that do not have any other means of borrowing, and whose failure to obtain credit would dramatically affect the economy.

Understanding Lender of Last Resort

The lender of last resort functions to protect individuals who have deposited funds—and to prevent customers from withdrawing out of panic from banks with temporarily limited 澳洲幸运5官方开奖结果体彩网:liquidity.

Commercial banks usually try not to borrow from🌄 the lender of last resort because such action indicates that the bank is experiencing a financial 🦹crisis.

Critics of the lender-of-last-resꦗort me🐼thodology suspect that the safety it provides inadvertently tempts qualifying institutions to acquire more risk than necessary since they are more likely to perceive the potential consequences of risky actions as less severe.

Lender of Last Resort and Preventing Bank Runs

A bank run is a situation that occurs during periods of financial crisis when bank customers, worried about an institution's solvency, 澳洲幸运5官方开奖结果体彩网:descend on the bank en masse and withdraw funds. Because banks only keep a small percentage of total deposits as cash, a bank run can quickly drain a bank's liquidity and, in a perfect example of a self-fulfilling prophecy, cause the bank to become insolvent.

Bank runs and subsequent bank failures were prevalent following the 1929 stock market crash that led to the 澳洲幸运5官方开奖结果体彩网:Great Depression. The U.S. government responded with new legislation imposing reserve requirements on banks, mandating they hold above a certain percentage of liabilities as cash reserves.

Criticisms of Lenders of Last Resort

Critics of the practice of having a last-resort lender allege that it encourages banks to take unnecessary risks with customers' money, knowing they can be bailed out in a pinch.

Such claims were validated when large financial institutions, such as Bear Stearns and American International Group, Inc., were bailed out in the midst of the 2008 financial crisis. Proponents state that the potential consequences of not having a lender of last r๊esort are far more dangerous than excessive risk-taking by banks.

The Bottom Line

A lender of last resort, often a central bank, provides emergency loans to financial𝄹 institutions facing difficulties to prevent them from collapsing and causing widespread economic damage.

This practice can prevent bank runs and ensure financial stability♈; however, i🌼t comes under criticism for encouraging risky behavior, as banks can expect to rely on bailouts when taking excessive risks.

Proponents of these practices state that the threat of not having a lender of last resort is even more risky and would be a greater threat to the financial ﷺsystem, as seen during the 2008 🦩financial crisis.