Financial Markets and Institutions Assignment Example | Topics and Well Written Essays - 2250 words

Financial Markets and Institutions - Assignment Example The basic foundation of a central bank serving as a lender of last resort is that in an economy, panics can occur which leads to bank runs. In such a situation, those maintaining deposits in commercial banks withdraw their funds from the bank as a result of economic speculation or fear over negative economic consequences. During a bank run, commercial banks can become insolvent, requiring the assistance of an institution (the central bank) to ensure that banks maintain liquidity is such a phenomenon occurs. Being the lender of last resort has become controversial, especially considering events during the recent global economic recession where many central banks injected capital into banks that were facing insolvency. Over-reliance on the central bank impacts other sectors in an economy. This essay explores the role of the central bank, emphasising why being a lender of last resort maintains many controversial implications from multiple perspectives. Evidence is that the controversy hails from irresponsible banking management and from poor fiscal policy developments concocted by the central bank itself. Central banks supply liquidity insurance to the commercial banking system which consequently endows liquidity insurance to other aspects of an economy, including corporations. Funds available for this action in a central bank encompasses notes held by public investors and reserves (deposits) sustained by a nation’s banks. These funds are manifested by the central bank as a result of autonomous will assuring that its value is comparable to products and services value in the economy. It is through these activities that an economy achieves macroeconomic stability. Concurrently, the central bank mandates the reserves that must be held by banks to insulate them from potential bank runs. Therefore, the central bank guarantees that commercial banks meet stringent standards of ensuring solvency. However, in 2007, many commercial