IAI Actuarial Core Principles · Business Economics · Role, structure and stability of the financial system
A central bank acting as 'lender of last resort' to the banking system primarily does which of the following?
A lender of last resort lends emergency funds to solvent banks facing a temporary liquidity shortage. By doing so it stops a loss of confidence at one institution from spreading through the system. It does not guarantee profits, fix loan prices or remove liquidity requirements.
- AProvides emergency liquidity to solvent but illiquid banks to prevent a loss of confidence spreadingCorrect
- BGuarantees the profits of all commercial banks each year
- CSets the prices of loans offered by commercial banks to customers
- DTakes over the ownership of any bank that makes a loss
- Replaces the need for banks to hold any liquid assets
Explanation
The lender of last resort supplies emergency funds against collateral to banks that are fundamentally sound but temporarily short of liquidity. This stops a run at one bank from becoming a systemic crisis. It does not guarantee profits, set loan prices, nationalise loss-making banks or remove liquidity requirements.
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