In India, the central bank’s function as the ‘lender of last resort’ usually refers to which of the following?
1. Lending to trade and industry bodies when they fail to borrow from other sources
2. Providing liquidity to the banks having a temporary crisis
3. Lending to governments to finance budgetary deficits
Select the correct answer using the code given below:
Explanation
The function of a central bank as the Lender of Last Resort (LOLR) is a fundamental pillar of systemic financial stability:
– Statement 1 is incorrect: The central bank does not directly extend credit to individual commercial corporations or trade/industrial bodies when they face private debt issues.
– Statement 2 is correct: When solvent commercial banks face a temporary liquidity crunch or run on deposits and are unable to obtain accommodation from the interbank money market, the central bank intervenes by providing emergency liquidity backing against eligible securities to prevent institutional panic and domino failures.
– Statement 3 is incorrect: Extending loans to governments for deficit financing represents the role of banker and debt manager to the government (or deficit monetization), not the lender-of-last-resort mechanism.
Therefore, only statement 2 is correct — Option B.