Functions of Central Banks Lender-of-Last-Resort

The lender of last resort (LOLR) function of a central bank is to provide loans to banks that are unable to obtain funding from other sources. This is done to prevent a bank run, which is a situation where depositors rush to withdraw their money from a bank, causing the bank to fail.

The LOLR function is important for maintaining financial stability. If a bank fails, it can have a ripple effect through the financial system, causing other banks to fail as well. By providing loans to illiquid banks, the central bank can prevent these failures and keep the financial system stable.

Multiple Choice Questions

  1. Which of the following is not a function of a central bank as a lender of last resort?
    • Providing loans to banks that are unable to obtain funding from other sources
    • Setting the discount rate
    • Managing the central bank’s balance sheet
    • Regulating and supervising banks
    • Issuing currency
    • Answer: Setting the discount rate
  2. The discount rate is the interest rate that the central bank charges to banks for loans. What does a higher discount rate mean for banks?
    • It is more expensive for banks to borrow money from the central bank.
    • It is less expensive for banks to borrow money from the central bank.
    • Banks are more likely to be able to obtain loans from other sources.
    • Banks are less likely to be able to obtain loans from other sources.
    • Answer: It is more expensive for banks to borrow money from the central bank.
  3. The central bank may choose to not lend money to a bank if the bank is considered to be:
    • Illiquid
    • Solvent
    • Well-managed
    • Profitable
    • Answer: Illiquid

Answers

  1. The answer is Setting the discount rate. The discount rate is set by the central bank, but it is not a function of the LOLR function.
  2. The answer is It is more expensive for banks to borrow money from the central bank. A higher discount rate means that banks have to pay more interest on the loans that they borrow from the central bank.
  3. The answer is Illiquid. The LOLR function is designed to help illiquid banks, but not insolvent banks. An insolvent bank is a bank that is unable to repay its debts.