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:

QUESTION

Easy

Economy

Prelims 2021

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:

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Explanation

Statement 1 is incorrect. The ‘lender of last resort’ (LoLR) function of the central bank primarily applies to commercial banks and financial institutions, not trade and industry bodies. Businesses and industries generally rely on commercial banks, financial institutions, and capital markets for funds. The Reserve Bank of India (RBI) does not directly lend to trade and industry bodies under its LoLR function.

Statement 2 is correct. The central bank (RBI) acts as the ‘lender of last resort’ for commercial banks facing liquidity shortages. This helps prevent bank failures and maintains financial stability. RBI provides liquidity through mechanisms like repo operations, open market operations (OMO), and special liquidity facilities.

Statement 3 is incorrect. The RBI does not directly lend to the government to cover budgetary deficits under the 'lender of last resort' function. The government primarily finances deficits through market borrowings, treasury bills, and bonds. However, RBI can indirectly support the government by purchasing government securities in the open market (OMO) or monetizing debt in special situations (historically, through ways and means advances - WMA).