Lender of Last Resort
What It Is
The Lender of Last Resort function allows the Federal Reserve to provide emergency liquidity to solvent banks facing short‑term funding shortages.
Why It Matters
This prevents bank runs, stabilizes markets, and stops liquidity crises from turning into solvency crises.
How It Works
- Fed lends against high‑quality collateral.
- Loans are short‑term and at a penalty rate.
- Used only when private funding markets freeze.
Key Components
- Emergency lending
- Collateral requirements
- Discount rate
- Crisis response mechanisms
Example
During the 2008 crisis, the Fed acted as lender of last resort to prevent systemic collapse.
Key Takeaways
- Essential for financial stability.
- Prevents contagion during crises.
- Supports solvent but illiquid institutions.