Lender of Last Resort
An institution, typically a central bank, that provides emergency liquidity to prevent systemic financial collapse.
What is Lender of Last Resort?
A lender of last resort is an institution — most commonly a central bank — that stands ready to provide emergency loans to financial institutions that cannot obtain funding from other sources, in order to prevent widespread bank failures and systemic collapse. The concept was articulated by Walter Bagehot in the 19th century: central banks should lend freely at a penalty rate against good collateral to solvent but illiquid institutions. In the U.S., the Federal Reserve serves as lender of last resort through its discount window and emergency lending facilities. This function is critical for financial stability but can create moral hazard if institutions believe they will always be rescued.
Example
During the 2008 financial crisis, the Federal Reserve dramatically expanded its lender of last resort role, extending $29 billion to facilitate the sale of Bear Stearns and later creating numerous emergency lending facilities including the Primary Dealer Credit Facility (PDCF) and the Commercial Paper Funding Facility (CPFF). These interventions prevented a cascade of institution failures that could have devastated the real economy.