Central Bank of a country – Meaning and Functions of Central Bank
Central Bank: Central banking functions have evolved gradually over decades. Their evolution has been guided by ever changing need to find new methods of regulating, guiding and helping the financial system (particularly, the banks). In other words, the evolution of central banking functions has tended to coincide with the evolution of the financial systems of the world economies. There are two types of functions that a central bank performs, namely
Central Bank is the apex of the banking system in a country. It controls, regulates and supervises the activities of the banks and the country’s banking system.
In our country the Central Bank was established in 1935 under private management. It was nationalized by the Government in 1949 and named as RBI.
Objectives of the Central Bank:
The Central Bank functions with the objectives given below:
- To maintain the internal value of currency.
- To preserve the external value of currency.
- To ensure price stability.
- To promote financial institutions.
- To promote economic development
Functions of Central Bank
A Central Bank is one which constitutes the apex of the monetary and banking structure of a country and which performs, in the national economic interest, the following functions :
- The regulation of currency in accordance with the requirements of business and the general public.
- The performance of general banking and agency services for the State.
- The custody of cash reserve of the commercial banks.
- The custody and management of the nation’s reserves of international currency.
- The granting of accommodation, in the form of rediscounting or collateral advances to commercial banks, bill brokers and dealers.
- The clearance arrangements among banks; and
- The control of credit in accordance with the needs of business with a view to carrying out broad monetary policy adopted by the State.
The above is quite comprehensive but, in addition, central banks perform additional functions to meet the specific requirements of the country. Broadly speaking, a central bank has three objectives, namely monetary stability, including stability of domestic price levels, maintenance of the international value of the nation’s currency and issue of currency.
1. Note Issue:
The Central Bank alone is authorized to issue the currency notes in a country. It has the monopoly of note issue as no other bank is permitted to do so. It also enables the Central Bank to control the supply of money as per the requirements of the economy.
2. Banker to Government:
The Central Bank acts as a banker, agent and financial advisor to government in the following ways:
- (a) It maintains the accounts of the government funds.
- (b) It receives money and makes payments on behalf of the government.
- (c) It gives ‘ways and means’ advances to the government.
- (d) It issues new loans on behalf of the government.
- (e) It manages the public debt.
- (f) It undertakes foreign exchange transactions on behalf of the government.
- (g) It acts as the agent of the government in dealing with the international financial institutions like IMF and World Bank.
- (h) It advises the Government on all financial matters.
3. Banker’s Bank:
The main function of a central bank is that of being a bank to the banks. This signifies that the central bank has the same relationship with the commercial banks in the country that the latter share with their customers. It provides security to their cash reserves, gives them loan at the time of need, gives them advice on financial and economic matter and work as clearing house among various member banks.
4. Lender of last resort:
The Central Bank serves a lender of last resort not only to commercial banks but also to discount houses, and other credit institutions. They may approach the central bank when they face the problem of liquidity.
5. Controller of credit:
This is the most important function of the Central Bank. It controls the volume of credit in the economy through appropriate monetary policy. It takes steps to reduce the credit in case of inflation.
6. Custodian of foreign exchange reserves:
The Central bank maintains the reserves of foreign exchange and regulates their use. It has the responsibility to maintain the stability of the exchange rate of the native currency in terms of the foreign currency.
Central bank is the custodian of the foreign currency obtained from various countries. This has become an important function of central bank. These days, because with its help it can stabilize the external value of the currency. This arrangement helps the authorities in managing and co-ordinating the monetary matters of the country more effectively. This is because there is a direct association between foreign exchange reserves and quantity of money in the market.
The foreign exchange reserves are influenced by international capital movements, international trade credits etc. Because of the interaction between the domestic money supply, price level, and exchange reserves, the central bank frequently faces several contradictory tendencies which have to be reconciled.
Management and Regulation of Exchange Rate:
A related function which is assigned to the central bank is the management, regulation and stabilisation of the exchange rate. This task is facilitated when the central bank is also the custodian of official foreign exchange reserves. The need for a stable exchange rate has emerged with the rapidly growing global connections. In this context, it was essential that this function be handled by an expert agency; for which central bank of the country is considered the best agency.
The central bank being the apex institution of the entire financial system of the country possesses maximum data and has the expertise of estimating the financial trends and the type of corrective measures needed. Moreover, it has several regulatory powers over the financial system. It can contemplate and take the complementary measures needed for ensuring the success of the steps taken in the area of exchange rate.