Vision Credit Education, Inc.

As the name implies, lenders of last resort (LOLR) are financial institutions willing to extend credit when no other institution is. The purpose of these lenders is to prevent panicked withdrawal and damage to the economy and depositors caused by the collapse of an institution. In the U.S., the Federal Reserve is the primary lender of last resort.

The Federal Reserve was created to prevent another financial crisis like the panic of 1907. In that year, rumors that the National Bank of Commerce was insolvent caused a flurry of withdrawals from that bank and other banks, as well. As you can imagine, these banks were not able to honor all of these withdrawals.

The Federal Reserve Act of 1913 created the Federal Reserve or Fed. Its role as a lender of last resort is to prevent another panic by decreasing interest rates, which allow banks or other commercial entities on the verge of collapse to borrow money and stay afloat.

Critics of the Fed’s role as a lender of last resort believe that it promotes more risky behavior in the institutions it helps because they have an out if they get into trouble. Before the Fed, those institutions would simply collapse as a result of their poor decisions.

A lender of last resort is also a term that is used in student loans. The same idea persists: those students who do not qualify for a loan from any other institution can obtain one from a designated lender of last resort. The Higher Education Act (HEA) contains a provision that allows certain lenders to be designated by the U.S. Secretary of Education as lenders of last resort. This provision of the HEA has rarely been used, but the recent Ensuring Continued Access to Student Loans Act of 2008 expands it significantly.

For more information about the specifics of that Act, look to the article Shrinking Student Loan Options.