Lender Of Last Resort Flashcards, test questions and answers
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What is Lender Of Last Resort?
A lender of last resort is an institution that provides emergency funds to financial institutions in times of crisis. It is typically a central bank or other governmental body, and its primary purpose is to prevent widespread economic collapse by providing liquidity to banks that are unable to obtain it from other sources. The lender of last resort can provide loans or grants, and may even purchase assets from the banks in order to keep them afloat.The concept originated during the early 19th century when governments first began issuing paper money. At this time, there were no official lenders of last resort, so private goldsmiths would often serve as a form of unofficial lender by providing loans against gold deposits. By the mid-19th century, banks had become more common and governments began establishing central banks which could act as lenders of last resort. Today, most countries have some form of government-backed lender of last resort in place in order to prevent systemic financial collapse by providing liquidity when needed.The role of the lender of last resort has come under scrutiny since the global financial crisis which began in 2008. Critics argue that these entities should not provide rescue loans unless they are absolutely sure that it will be paid back with interest down the line; otherwise it creates moral hazard and encourages irresponsible lending practices among financial institutions. On the other hand, proponents argue that inaction on behalf of a lender can lead to catastrophic results if left unchecked; thus intervention may be necessary at times due to systemic risk posed by certain situations. Regardless, it’s clear that lenders of last resort play an important role in keeping economies stable during times when regular sources for lending are scarce or unavailable due their own instability or for regulatory reasons (such as capital requirements).