lenderoflastresort

A lender of last resort is a central bank or other monetary authority that provides liquidity to financial institutions or markets during extraordinary funding pressures when normal sources of funding are unavailable. The main purpose is to prevent systemic collapse and stabilise the financial system, especially to forestall bank runs and widespread insolvencies.

In practice, lender-of-last-resort support is typically provided as short-term loans or liquidity facilities, often secured by high-quality collateral. The lending is intended for solvent but illiquid institutions, and terms may include higher policy rates or penalties and clear eligibility standards. Central banks may use various tools, such as discount windows, emergency lending facilities, or term lending facilities, to inject liquidity into banks and markets when market functioning deteriorates.

Historically, the concept is associated with the Bank of England and the 19th-century banker Walter Bagehot, who argued that a central bank should lend freely, at a penalty rate, against good collateral, to solvent but illiquid banks during crises. In the modern era, crises such as the 2007–2009 financial crisis and the euro area debt crisis led major central banks to expand LLR facilities beyond ordinary operations, extending support to non-bank sectors and broad markets to restore confidence and liquidity.

Controversies and limitations include concerns about moral hazard, whereby institutions might take excessive risks if they expect rescue, and the potential fiscal costs if losses occur. Effective LLR support is typically accompanied by strong supervision, credible crisis management frameworks, clear criteria for eligibility, and macroprudential policies to reduce systemic risk.