What is a lender of last resort?
A bank does not keep all your deposits sitting in its vault. Most of the money is out on loans that will come back over months or years. So if every depositor wants their money at once, even a sound bank runs short of cash. This is a liquidity crisis: the bank has assets, but not enough cash right now.
At such a moment, the central bank can lend cash to that bank against collateral, so depositors get paid and the panic does not spread to other banks. Because the central bank can lend when nobody else will, it is called the “lender of last resort”. In Bangladesh, this role belongs to Bangladesh Bank.
Say a rumour spreads in a town that a bank is “going under”. Even though it is not true, there is a long queue at the counter from the morning. The bank’s loans and government bonds are fine, but they cannot be turned into cash today. The bank pledges the bonds to the central bank and borrows cash, everyone is paid, and within a few days the queue shrinks. This is only an illustrative example.
Why it matters to an investor
- To understand how panic spreads: bank runs often start with rumours and can jump from one bank to another. A lender of last resort is one way to break that chain.
- To tell liquidity from solvency: a temporary cash shortage is not the same as losses wiping out a bank’s capital. Central bank lending is meant for the first; the second needs other measures.
- To know how your own deposits are protected: under the deposit protection law, each depositor gets money back up to a limit. Knowing the limit helps you think about where to keep larger sums.
- To read market news: headlines about “special liquidity support” or “borrowing through repo” are part of this same role.
Bagehot’s rule
The British journalist Walter Bagehot set out the best-known rule for this role in his 1873 book “Lombard Street”. Central banks around the world still treat it as a starting point.
- In a panic, lend quickly and freely, so the fear of “no cash” itself goes away.
- But charge a high rate, so only those who really need it borrow, and banks return to other sources once the crisis passes.
- Lend only against good collateral, such as government bonds and other assets that are easy to sell. This helps sound banks with a temporary problem, not banks that are fundamentally broken.
How it works in Bangladesh
Under the Bangladesh Bank Order 1972, Bangladesh Bank can make short-term loans to scheduled banks against specified collateral, and in special circumstances, if the Board or Governor considers it warranted, against other security too. On ordinary days, banks borrow for short periods from Bangladesh Bank through facilities such as repo or the standing lending facility, pledging government securities.
A second safety net for depositors is deposit protection. Under the Deposit Protection Act 2026, if a member bank is liquidated, each depositor gets up to Tk 2 lakh from a fund held at Bangladesh Bank, up from Tk 1 lakh under the previous law. Anything above that has to be claimed from the liquidator. Finance companies must become members by 1 July 2028. The limit is to be reviewed every three years, so it can change.
The limits of this role
- Central bank lending is meant for temporary cash shortages. A bank whose capital has been wiped out by large loan losses cannot be fixed by lending alone.
- Economists call one danger “moral hazard”: if banks assume help will always arrive, they may take bigger risks. That is why the high rate and strict collateral conditions matter.
- To make large emergency loans, the central bank creates new money, which in large amounts can add to inflation pressure. Economists often disagree about how much is appropriate.
Worked example
- Say a bank has deposits of Tk 1,000 crore. Of its assets, Tk 100 crore is cash and balances at the central bank, Tk 200 crore is government bonds and Tk 800 crore is loans (the rest is funded by the owners’ capital).
- After a rumour, depositors try to withdraw Tk 250 crore in one week. The Tk 100 crore of cash is not enough; the gap is Tk 150 crore.
- The loans cannot be sold today, and a fire sale would mean heavy losses. But the bank can pledge its Tk 200 crore of bonds and borrow Tk 150 crore from the central bank.
Result: every depositor was paid, the loans were not dumped, and the panic stopped. As loans are repaid, the bank pays back the central bank. The numbers are only an example.
Common mistakes
- Thinking the central bank will rescue any bank in any situation. The role is for temporary cash shortages, and comes with conditions.
- Treating the deposit protection limit as a per-account limit. Under the law, it covers all of one depositor’s accounts at one institution together.
- Rushing to break deposits early on a rumour, without checking the facts. Panic itself can create a crisis.
- Assuming deposit protection for banks and finance companies started at the same time on the same terms; finance companies have a separate membership deadline.
In a panic, the central bank protects the whole system by lending cash to banks against collateral, but wiping out losses from bad management is not its job.