Money
Reserve Bank is the only institution which can issue currency. When commercial banks need more funds in order to be able to create more credit, they may go to market for such funds or go to the Central Bank. Central bank provides them funds through various instruments. This role of RBI, that of being ready to lend to banks at all times is another important function of the central bank, and due to this central bank is said to be the lender of last resort. The RBI controls the money supply in the economy in various ways. The tools used by the Central bank to control money supply can be quantitative or qualitative. Quantitative tools, control the extent of money supply by changing the CRR, or bank rate or open market operations. Qualitative tools include persuasion by the Central bank in order to make commercial banks discourage or encourage lending which is done through moral suasion, margin requirement, etc.
Open Market Operations refers to buying and selling of bonds issued by the government in the open market. This purchase and sale is entrusted to the Central bank on behalf of the government. There is another type of operation in which when the central bank buys the security, this agreement of purchase also has specification about date and price of resale of this security. This type of agreement is called a repurchase agreement. The interest rate at which the money is lent in this way is called the repo rate. Similarly, instead of outright sale of securities the central bank may sell the securities through an agreement which has a specification about the date and price at which it will be repurchased. This type of agreement is called a reverse repurchase agreement.
Who is the lender of last resort?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Central Bank
A commercial bank that runs short of funds, in a crisis or to create more credit, may find no one else willing to lend to it. It can then turn to the central bank, which, as the passage says, is ready to lend to banks at all times. That role makes the central bank the lender of last resort, and in a crisis it guarantees the solvency of the commercial banks.
Why the other options are incorrect
Option (1) Commercial Banks — Incorrect. Commercial banks accept deposits and lend to the public. They are the ones who borrow from the central bank when they run short of funds, not the last resort for others.
Option (2) Regional Rural Banks — Incorrect. Regional rural banks provide credit to small farmers and others in rural areas. They too depend on higher institutions for funds and cannot guarantee other banks.
Option (3) Cooperative Banks — Incorrect. Cooperative banks are owned by their members and lend mainly to them, in villages and towns. They are borrowers in a crisis, not the lender of last resort.