The Central Bank acts as a Banker’s Bank because it allows the commercial banks to maintain current accounts with it. They can borrow money from the latter in very short term. The Central Bank has an issuing monopoly when it comes to currency, and the commercial banks borrow money from the Central Bank to supply banknotes to customers, either over the counter or through Automatic Teller Machines.
The Central bank debits the current accounts of the commercial banks accordingly and similarly debts can be settled. A minimum credit balance is required to be maintained with the Central Bank, known as the monetary reserves. All this creates a need for liquidity.
(ii) Lender of last resort
A lender of last resort refers to an institution which is willing to offer loans as a last resort. It has the power to offer an extension of credit to financial institutions experiencing financial difficulty which are unable to obtain funds elsewhere.
The Central Bank’s main function as a lender of last resort is to preserve the stability of the banking and financial system by protecting individual’s deposited funds and preventing panic-ridden withdrawing from banks with temporary limited liquidity.
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