📘 Q.14 IAS Prelims 2021 — Economics (Lender of Last Resort)
🧷 Authentic Classrom Explanation by IAS Monk
📌 The 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:
(a) 1 and 2
(b) 2 only
(c) 2 and 3
(d) 3 only
📌 Correct Answer: (b)
🧠 Classroom Explanation
The Reserve Bank of India (RBI) acts as the Banker to Banks, and under this role, it performs the crucial function of Lender of Last Resort (LoLR).
❌ Statement 1: Incorrect
RBI does not lend to trade or industry bodies under the LoLR function.
Its emergency lending support is restricted to banks and financial institutions, not private businesses or industrial entities.
✅ Statement 2: Correct
The core meaning of Lender of Last Resort is:
👉 Providing emergency liquidity to solvent banks facing temporary liquidity stress, when no other source of credit is available.
This function:
- Prevents bank failures
- Protects depositors’ money
- Preserves confidence in the financial system
- Avoids systemic contagion
❌ Statement 3: Incorrect
Lending to governments to finance budgetary deficits is not LoLR.
That would amount to monetisation of deficit, which is distinct from emergency banking support and is tightly regulated under law.
➡️ Hence, only Statement 2 is correct.
✨ Enrichment Points (Prelims Edge)
- LoLR ≠ routine lending → it is emergency liquidity support
- Provided only to solvent but illiquid banks
- Objective is financial stability, not profit
- In India, this is operationalised through tools like:
- Repo window
- Marginal Standing Facility (MSF)
🔍 Curiosity Raiser
Why does the RBI support a troubled bank but refuses to rescue a troubled company — even if both are “too big to fail”?
🧘 IAS Monk Whisper
A central bank stands silent in prosperity,
but must roar in crisis —
not to save banks,
but to save trust.