Question

What does it mean for a central bank to act as lender of last resort?

Answer 1

Lender of last resort means that central bank is the source which can come in handy when the financial institution is not able to raise finance from any other resources.

A financial institution like banks have different sources to raise capital like using their reserves, using the money deposited by the bank customer, borrowing from other banks or government etc, the banks may be successful or not successful depending on different circumstances in raising finances for these various different ways, but even whn they are unsuccessful they always have an option to borrow from Fed.

That is the reason why FEd is considered as lender of last resort because the financial institutions can always depend on borrowings from FED in any case. FED lends at discount rate set by the FOMC.