Prelims 2021

Q. 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:
a) 1 and 2 only
b) 2 only
c) 2 and 3 only
d) 3 only
Correct Answer: b) 2 only

Question from UPSC Prelims 2021 GS Paper

Explanation : 

Reserve Bank of India as Lender of Last Resort

The term “lender of last resort” traditionally refers to the role of a central bank in providing liquidity to the banking system when no other institution is willing or able to do so. In the context of India, the central bank is the Reserve Bank of India (RBI). The RBI, as the lender of last resort, primarily fulfills the following function:

Providing Liquidity to Banks During Temporary Crisis

When banks face a temporary liquidity crisis and cannot obtain funds from other sources, they can turn to the RBI for short-term loans. This is crucial in preventing a liquidity shortfall in one bank from cascading into a systemic crisis that affects the entire banking system.

The other options provided in the question are not typically roles of a central bank as a lender of last resort:

Lending to trade and industry bodies when they fail to borrow from other sources – This is not a central bank’s role. While central banks may implement policies that indirectly support the broader economy, they do not directly lend to trade and industry bodies.

Lending to governments to finance budgetary deficits – Central banks may purchase government securities or engage in other monetary policy operations that affect government financing, but this is not the same as acting as a lender of last resort. Financing government deficits is generally done through borrowing from the public or financial institutions, not through last-resort lending.

Therefore, the correct answer is “2 only,” which refers to the RBI’s role in providing liquidity to banks during times of temporary crisis to ensure the stability of the financial system.

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