Central bank functions-lender of last resort, Managerial Economics

Lender of Last Resort

The central bank also acts as the lender of last resort. Historically, this function developed out of the special position of the central banks. The central bank was granted monopoly of note issue in the country and its notes were unlimited legal tender. The centralisation of the metallic reserves further added strength to the central bank to perform its functions as lender of the last resort. In its capacity of lender of the last resort , the central bank meets directly or indirectly all reasonable demands for financial accommodation from the commercial bank discount houses and other credit institution subject to certain terms and conditions which constitute its discount rate policy. Today this function is regarded as the sine qua non of central banking.

The great importance of central bank function as lender of last resort was stressed by Walter Bagehot in 1873 in his well known book Lombard street wherein he drew the attention of the bank of England to act as lender of the last resort by providing rediscount facilities to the banking system in times of financial crises if it had to be called the true central bank. The classic statement of Bagehot runs. Theory suggest and experience proves, that in a panic the holders of the ultimate bank reserve (whether one bank or many) should lend to all that bring good securities quickly, freely and readily. By that policy they allay a panic by every other policy they intensify it. The public have a right to know whether the bank of England the holders of our ultimate bank reserve ac knowledge this duty , and are ready to perform it. But this is now very uncertain.

Nothing therefore can be more certain than the bank of England has in this respect no peculiar Peculiar privilege that it is simply in the position of a bank keeping the banking reserve of the country that it must in time of panic do what all other similar banks must do that in time of panic it must advance freely and vigorously to the public out of the reserve. After the publication of Bagehot Lombard street. Bank of England responsibility as the lender of last resort was unequivocally recognised. The term lender of last resort was coined by Walter Bagehot. After the assumption of the role of the lender of last resort by the bank of England, other central banks took it as a matter of fact and routine. Nowadays central banks perform this function ungrudgingly.

Posted Date: 12/1/2012 6:51:41 AM | Location : United States

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