Previous Year Question
In India, the Central Bank’s function as the ‘lender of last resort’ usually refers to which of the following?
Lending to trade and industry bodies when they fail to borrow from other sources.
Providing liquidity to the banks having a temporary crisis.
Lending to governments to finance budgetary deficits.
Select the correct answer using the code given below:
1 and 2 only
2 only
2 and 3
3 only
Correct Answer: B
Detailed Solution
The Lender of Last Resort function refers to the central bank’s provision of emergency liquidity to a solvent bank, or to the banking system, facing a temporary liquidity crisis.
Statement 1 is incorrect.
A central bank does not ordinarily provide loans directly to trade or industrial enterprises. Their credit requirements are generally met by commercial banks, financial institutions and the capital market.
The inability of a business enterprise to obtain credit from other sources does not, by itself, make the RBI its lender of last resort. This function is primarily concerned with banks and the stability of the financial system.
Statement 2 is correct.
A bank may possess sufficient assets but experience an immediate shortage of cash because of sudden withdrawals or short-term financial pressure. During such a temporary liquidity crisis, the central bank may provide liquidity against eligible securities or under other prescribed conditions.
The purpose is not to cover the bank’s permanent losses, but to prevent a temporary cash shortage from developing into a wider banking panic or systemic crisis.
Lender-of-last-resort support does not imply an unconditional rescue of every distressed bank. The central bank may consider solvency, available collateral, systemic importance and moral-hazard concerns.
Statement 3 is incorrect.
Lending to the Government to finance a budgetary deficit is not the central bank’s lender-of-last-resort function. Government borrowing is ordinarily mobilised through the issuance of government securities and Treasury Bills.
The RBI acts as the Government’s banker and public-debt manager, but those functions are distinct from providing last-resort liquidity to a bank facing a temporary crisis.