Question

Define the following concepts (i) Liquidity crisis (ii) lender of the last resort (iii) shadow banks

Answer 1

I) liquidity crisis:-

• It refers to the shortage of cash in the banks or other depository institutions which makes them incapable of fulfilling their short term obligations.
• A liquidity crisis is accompanied by a decrease in the fall in value and prices of assets which forces the holders to sell their assets at lower rates than expected.

ii) lender of the last resort:-

• The central bank of any country is said to be the lender of last resort.
• This is because it provides loans or credits to other depository institutions when they are unable to meet their short term obligations due to liquidity crisis.
• The federal Reserves acts as saviors to protect the depository institutions when they are about to collapse or when they are facing financial crisis.

iii) shadow banks:-

• It refers to some chain of banking regulations and markets to provide services like credit creation.
• These banks functions in a similar way like the commercial banks.But the only difference is in the absence of regulations.