What Is a Lender of Last Resort?

A lender of last resort is a term that encompasses a wide variety of lending institutions that provide financing to businesses and individuals that are suffering from severe financial problems.The loans are offered because no one else will offer financing. The Federal Reserve functions as the lender of last resort for companies that are regarded as being "too big to fail," while private lenders of last resort provide loans in hopes of making profits off interest. Either way, borrowing from a lender of last resort can have financial consequences in the long run. Before you take one of these loans, you should carefully consider your options.

Lending and Risk

When a lender gives money to the borrower, it does so in hopes of eventually getting the money back. On the other hand, it wants to earn as much profit off giving out a loan as it possibly can. The only way they can earn profit is by charging interest, and other fees. While lenders try to limit their lending to borrowers who are likely to repay the loans back, they are not entirely adverse to lending to riskier clients. Since a riskier borrower is less likely to repay the loan, the lenders try to make up for potential loss by charging higher interest rates so that they will at least get more profit out of the borrower than they would out of their more financially sound clients.

Federal Loans

Federal government loans have a different type of risk. As long as the government functions, it will continue to collect taxes and generate revenue. While the government may run short of money, it will never become completely bankrupt, unless it suffers a complete collapse. As a result, the government can afford to take more risk than private lenders and offer money without worrying about financial losses.

Federal Reserve as the Lender of Last Resort

The Federal Reserve serves as a lender of last resort for government agencies and major private lending institutions. The financial collapse of many institutions can affect millions of Americans. By providing loans of last resort, the federal government aims to help stabilize the economy, giving those institutions enough money to weather the economic downturn and return to profitability.

The Federal Reserve has served in the lending role since the Great Depression. Most recently, it served as a lender of last resort to several major financial institutions in what has become known as the bank bailout. Also, the Consumer Protection Act contains several provisions that aim to reduce Federal Reserve's lending of last resort, but whether or not this will work remains to be seen over time.

Private Lenders of Last Resort

There are also private lenders that serve as lenders of last resort to individuals and companies. For them, the lending is about their own profits rather than the country's overall stability. The loans are very high risk so the rates for these types of programs are very high when compared to conventional loans. Private lending institutions can be found online.

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