Central Bank: The Central Bank is the supreme monetary and banking authority. According to De Cock, "a central bank is a bank which constitutes the apex of the monetary and banking structure." In the statutes of Bank for International Settlement (BIS), a central bank is defined as "the bank in any country to which has been entrusted the duty of regulating the volume of currency and credit in that country."
Functions:
Monetary Management, Banking Supervision and Developmental.
A. MONETARY MANAGEMENT:
Note
issuance
Previously
almost every bank could issue notes. It led to over issue of notes very often
and as such it created many troubles. Then Government decided to give the power
of issuing notes to a single institution. Now the central bank enjoys the sole
right to issue notes. Notes are issued according to requirements on the basis
of a certain principle.
The
notes issued by the central bank represent cash. This cash constitutes the
assets of other banks. Hence, the note-issue function is necessary for the
central bank to control the banking system by being the ultimate source of
cash.
Banker
to the Government
The central bank acts
as the banker to the government in the following ways:
a. It acts as the custodian of all the funds of the government. The bank usually pays no interest on these balances.
b. All payments of the government are made
through the central bank.
c. The central bank also acts as the lender to
the government in times of financial difficulties. The loans are allowed on
short-term basis against treasury bills and other securities.
d. It acts as the adviser to the government
about financial matters. e. It manages
the public debt on behalf the government.
Banker's Bank
The
central bank acts as the banker to the commercial banks. The commercial banks,
either by law or custom, have to maintain a certain percentage of their
deposits as cash reserves with the central bank. The reserve maintenance allows
the central bank to exercise control over the activities of those banks.
Clearing House Operation
The
central bank acts as the clearing house for other banks. Its function in this
respect is to help the settlement of their mutual claims that arise by way of
collection and payment to cheques. All banks have their reserves with the
central bank. They settle their clearing differences by drawing cheques on the
central bank. The central bank will clear up these differences by means of
debit and credit entries in their accounts with it.
Lender of the last Resort
The
central bank not only maintains the reserves of the commercial banks, it also
acts as the lender of the last resort to them. Sometimes they fail to meet the
depositor’s demand for cash. They may not get funds from other sources to meet
their demand. Then they can approach the central bank for help in such and
other emergency needs. The purpose of the Central bank is not to compete with
them but to help them. Hence, the central bank will come forward to provide
these banks with necessary funds. The funds are allowed by rediscounting their
bills of exchange, promissory notes and other commercial papers or against
approved securities. Thus, the central bank acts as the lender of the last
resort or the ultimate source of cash to other banks.
In
times of financial crisis and panic, the central banks help the commercial
banks not only by granting advances but by giving them benefit of advice as
well.
Foreign
Exchange Operations
The
value of national currency may fluctuate both at home and abroad. The central
bank is to keep certain reserves for maintaining confidence in home currency.
This reserve is the safeguard against domestic monetary circulation. Similarly,
it is to keep necessary foreign exchange
reserves for maintaining
stability in the
external value of
national currency. Hence, the
central bank acts as the custodian of the foreign exchange reserves and
conducts foreign exchange operations in such a way as to keep the external
value of the currency stable.
Controller of Credit.
The very important function of a central bank is that it acts as the controller of credit. Expansion and contraction of credit may be associated with many evils. As the leader of the money market, the central bank controls the volume of credit according to the total needs of the economy. The supply of credit takes place through the commercial banks. Hence, the central bank regulates their credit creation activities through different instruments of control, such as the bank rate, open market operation, variable reserve ratio and selective methods.
B. BANKING SUPERVISION:
The process of bank supervision takes two forms. One is the regulatory or off-site monitoring process, while the other is on-site inspection or bank examination process. Bank regulation usually deals with the formulation and implementation of specific rules and regulations for the conduct of banking business, including the monitoring of the compliance with such rules. Bank examination, on the other hand, ensures compliance with the rules and regulations and assesses the soundness of individual institutions. Sometimes, the function of bank regulation and examination are centered in one department, while in some central banks, they are separated into different departments as a matter of policy.
C. DEVELOPMENTAL FUNCTIONS:
In the under-developed countries, the central bank takes keen interest in the promotion of economic development. It also takes part in the development of commercial and other banking institutions. This development function does not fall within the traditional functions of a central bank.
Money supply:
The total supply of money in circulation in a given country's economy at a given time. There are several measures for the money supply, such as M1, M2, and M3. The money supply is considered an important instrument for controlling inflation by those economists who say that growth in money supply will only lead to inflation if money demand is stable. In order to control the money supply, regulators have to decide which particular measure of the money supply to target. The broader the targeted measure, the more difficult it will be to control that particular target. However, targeting an unsuitable narrow money supply measure may lead to a situation where the total money supply in the country is not adequately controlled.