Question 96 from UPSC CSE 2021 - Economics

Question

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.

Accepted Answer

Correct Option: B. 2 only

Strategy: - Focus on the standard textbook definition of 'lender of last resort,' which is the central bank providing temporary liquidity to banks during financial distress.
- Identify that Statement 2 matches this definition.
- Exclude Statement 1, as it refers to trade and industry, which is outside the traditional scope of the function.
- Exclude Statement 3, as it concerns financing government budgetary deficits, a separate function from the lender of last resort.
- Conclude that only Statement 2 is correct.

Key Info: **Lender of Last Resort Function**

The 'lender of last resort' is a key function of central banks globally, including the Reserve Bank of India (RBI). This role is vital for the stability and confidence in the financial system.

**Core Responsibilities**
- Supplying emergency liquidity to commercial banks facing temporary shortages.
- Preventing systemic bank failures by supporting banks unable to borrow from other sources.
- Safeguarding depositor interests and preserving overall financial stability.
- The facility is typically used to support only solvent banks with temporary liquidity issues.

**Scope and Limitations**
- The function does not involve lending directly to trade or industry bodies.
- It is distinct from financing government budgetary deficits, which is managed through separate instruments like Ways and Means Advances or market borrowings.

**Statutory Framework**
- The RBI's primary statutory framework for this function is provided by the RBI Act, 1934.

Answer

Option A: 1 and 2

Answer

Option C: 2 and 3

Answer

Option D: 3 only