Lender of last resort
A
lender of last resort is an institution willing to extend
credit when no one else will.
Originally the term referred to a reserve
financial institution that secured other banks or eligible institutions, as a last resort; most often the
central bank of a country. The purpose of this
loan and lender is to prevent the collapse of institutions that are experiencing financial difficulty, most often near collapse.
The lender of last resort serves to protect
depositors, prevent widespread
panic withdrawal, and otherwise avoid damage to the
economy caused by the collapse of an institution. Borrowing from the lender of last resort by
commercial banks is usually not done except in times of crisis. This is because borrowing from the lender of last resort indicates that the institution in question has taken on too much risk, or that the institution is experiencing financial difficulties (since it is often only possible when the borrower is near collapse.)
In the
United States the
Federal Reserve serves as the lender of last resort to those institutions that cannot obtain credit elsewhere and the collapse of which would have serious implications on the economy. It took over this role from the private sector "
clearing houses" which operated during the
Free Banking Era; whether public or private the availability of liquidity was intended to prevent
'runs' on the banking system.
Alternatively, a
lender of last resort is a
bank,
check cashing store or
credit card operation which deals only with the highest-risk categories of private client. These retail banks charge very high rates of interest to cover the high
credit risk they face since many of the loans are not repaid. They therefore only attract customers unable to secure credit elsewhere, which would be at lower interest rates.
This term can be appiled to criminal
loan sharks who act as lenders of last resort, offering loans at very high rates of interest (considered by many as
usury). This may be illegal in itself, or involve intimidation to ensure repayment.
These
moneylenders are not the only lenders of last resort dealing with the public. In some cases, credit is available for the purchase of specific
goods which would not be given for
cash. Particularly in
car financing, there are large companies specializing in the arrangement of credit for high risk individuals.
Critics of the backing of institutions point to the ability of having a lender of last resort as a
temptation for an institution to take on more risk. If a lender of last resort provides a safety net to insulate the institution from the full consequences of their risk. The lending does not
underwrite the conseques but it could the business failure can be hidden for longer by the extenion of credit.
A more theoretical critique of the institution of a last resort lender is that its existence is predicated on the possibility of a "
market failure": if the
credit market accurately assesses risks then institutions not able to receive loans would probably misuse the capital and the idea of a panic or ‘contagious'
credit crunch spreading through the banking system would be impossible.
A modern critique of the
International Monetary Fund as the international lender of last resort is that it is effectively an inefficient subsidy system, since it is mandated to provide loans to countries unable to raise funds through the bond market, with loans paying below market interest rates. Critics say that this has two deficiencies as a means of charity: one, it confuses the ability to repay with the economic reorganization demanded by the bank and other
ethical considerations; and two, the fact that some countries actually do repay their loans, despite the hardship of paying and the reality that most
developing nations are not expected to do so.
*
Refund Anticipation Loan*
Payday loan
