Lender of last resort.

In plain English

As lender of last resort, the Federal Reserve supplies cash against good collateral when private lenders will not, which lets a bank meet withdrawals without dumping assets at fire sale prices. The classic rule of thumb is to lend freely, against sound collateral, at a penalty rate, so the help is available but not free. The point is to distinguish an institution that is short of cash from one that is short of value, and to keep the first kind from becoming the second. The tool creates a known tension, because a backstop that always appears reduces the incentive to hold enough liquidity in the first place. That tension is why access comes with supervision.

01Why it matters

This function is the reason an ordinary depositor's paycheck still clears during a panic, and the reason a run at one institution does not automatically empty accounts across the system.

02The math, step by step

Say a bank holds $2 billion of Treasury securities worth 97 cents on the dollar in a stressed market. Selling them raises about $1.94 billion and locks in a $60 million loss. Pledging them for a loan raises a similar amount with no loss, and the bank buys time.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

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