What is the function of the central bank's lender of last resort?

The function of the central bank's lender of last resort primarily involves providing liquidity to financial institutions during times of financial distress or instability. This role is critical to maintaining confidence in the financial system and preventing bank runs. When banks face short-term liquidity shortages, they may not be able to meet withdrawal demands from customers or fulfill their obligations. By acting as a lender of last resort, the central bank can provide the necessary funds to these institutions, enabling them to stabilize their operations without resorting to more drastic measures, such as selling off assets at fire-sale prices or ceasing operations, which could lead to broader financial crises.

This capability is essential for maintaining overall financial system stability, as it helps prevent contagion effects that can occur when one institution's failure negatively impacts others. It is a crucial function that helps ensure that financial markets operate smoothly and that credit remains available to consumers and businesses, even during periods of economic stress.