How Is The Federal Reserve Known As The Lender Of Last Resort

Federal Reserves as the Lender of Last Resort
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In order to clearly understand this notion, it is important to first of all ascertain the meaning of a last resort when it comes to monetary terms. A lender of last resort is simply a facility that comes in to avail loans when all the other possible avenues have proved unreliable. The purpose of a lender of last resort therefore, stems from the fact that it helps salvage the deposits of individuals by curtailing any panic withdrawals from financial institutions, thereby ensuring the stability and sustainability of the larger banking and financial industry within the country. Based on the country in question, different financial institutions therefore, may act as the ultimate lenders of last resort. For example, in India, it is the Bank of India, for U.K, it is the Bank of England and in NZ, it is the Reserve Bank of NZ. In most cases therefore, the nation’s central bank is usually the lender of last resort. Globally, the International Monetary Fund (IMF), takes up this responsibility and helps in handling challenges in the sector, such as the financial crisis that recently hit the world in 2008. For the U.S in particular, the Federal Reserve takes this onus as the Lender of Last resort, as per the nation’s constitution.
Federal Reserve in the United States serves as the Lender of last resort to such institutions that are unable to obtain financial assistance from anywhere else. At the same time, this institutions’ collapse could cause negative implications to the economy of the state. Initially, this role belonged to private sectors before it was taken over by the Federal Reserve. The private sectors operated this role during the Free Bank Era. The taking over of the role was meant to prevent bank runs.
Since depository institutions or other related entities may fail in some circumstances or during emergencies which could adversely affect the economy, the Federal Reserve has the authority and financial resources to act as “Lenders of Last Resort” to them. Federal Reserve extends financial assistance to institutions through credit operations and discounts. The banks for example, can be provided with financial aid either via credit or discounts to meet its short-term needs that may arise from unexpected withdrawals or the fluctuations in deposits that occur seasonally. The Fed also provides liquidity in the long term but exceptional circumstances. The charges' rates for the banks on these loans are usually the discount rates.
Providing loans by the Fed make it buffer the daily fluctuations of the supply and demand thus contributing to bank system's effective functionality. It also helps in pressure elevation in the reserve market. This extends to reducing the unexpected extent to the interest rates movements. A good example is when the insurance giant of the United States, American International Group (AIG) went bankrupt in 2008. To stave this bankruptcy, the Fed Board loaned it $85 billion (Boundless).
The Fed Board was made to be the Lender of Last Resort after its founders detected the inelasticity of the currency in the United States. The currency was inflexible and could not meet the economy activities' ordin...