Definition of lender of last resort

A central bank's role as the entity that lends money to commercial banks and other financial institutions when they have no other means to raise funds.

Source: Financial Times

The understanding that the central bank will always stand ready to lend money to a bank or number of banks experiencing a crisis if they cannot obtain finance from market sources.

Example

The first major bank to get into financial difficulties at the onset of the recent banking crisis, in late 2007, was UK's Northern Rock - the country's ninth largest bank.  Due to a run on the bank, where customers queued to get their deposits, the government had to step in and say that all depositors would be protected by the state. Here the authorities were acting as the lender of last resort.

Lender of last resort may lead to moral hazard problems, as there are concerns that some banks that know they will be bailed out may take on huge risks in the belief that they will be protected when things go wrong.

Philip Molyneux, professor of banking and finance, Bangor Business School

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