1. Regulator of Currency:
The central
bank is the bank of issue. It has the monopoly of note issue. Notes issued by
it circulate as legal tender money. It has its issue department which issues
notes and coins to commercial banks. Coins are manufactured in the government
mint but they are put into circulation through the central bank.
2. Banker,
Fiscal Agent and Adviser to the Government:
Central banks
everywhere act as bankers, fiscal agents and advisers to their respective
governments. As banker to the government, the central bank keeps the deposits
of the central and state governments and makes payments on behalf of
governments. But it does not pay interest on governments deposits. It buys and
sells foreign currencies on behalf of the government.
3. Custodian of
Cash Reserves of Commercial Banks:
Commercial
banks are required by law to keep reserves equal to a certain percentage of
both time and demand deposits liabilities with the central banks. It is on the
basis of these reserves that the central bank transfers funds from one bank to
another to facilitate the clearing of cheques.
4. Custody and
Management of Foreign Exchange Reserves:
The central
bank keeps and manages the foreign exchange reserves of the country. It is an
official reservoir of gold and foreign currencies. It sells gold at fixed prices
to the monetary authorities of other countries. It also buys and sells foreign
currencies at international prices. Further, it fixes the exchange rates of the
domestic currency in terms of foreign currencies.
5. Lender of the Last Resort: By granting accommodation in the form of
re-discounts and collateral advances to commercial banks, bill brokers and
dealers, or other financial institutions, the central bank acts as the lender
of the last resort.
6. Clearing
House for Transfer and Settlement:
As bankers’
bank, the central bank acts as a clearing house for transfer and settlement of
mutual claims of commercial banks. Since the central bank holds reserves of
commercial banks, it transfers funds from one bank to other banks to facilitate
clearing of cheques. This is done by making transfer entries in their accounts
on the principle of book-keeping. To transfer and settle claims of one bank
upon others, the central bank operates a separate department in big cities and
trade centres.
7. Controller of
Credit:
The most
important function of the central bank is to control the credit creation power
of commercial bank in order to control inflationary and deflationary pressures
within this economy. For this purpose, it adopts quantitative methods and
qualitative methods. Quantitative methods aim at controlling the cost and
quantity of credit by adopting bank rate policy, open market operations, and by
variations in reserve ratios of commercial banks.
Besides the
above noted functions, the central banks in a number of developing countries
have been entrusted with the responsibility of developing a strong banking
system to meet the expanding requirements of agriculture, industry, trade and
commerce.
In
principle, there is a clear division of responsibilities and accountabilities
between the central bank on the one hand, and the government and the Minister
of Finance on the other hand. Information sharing, cooperation and coordination
between the central bank and the government are important in a number of
respects. Fiscal Policies (Govt.
spending, taxes etc.) are determined by the Ministry of Finance while Monetary Policies (Interest rate, inflation
etc.) are formulated by the Central Bank.
Coordination of Monetary and Fiscal
Policy
If the
fiscal authorities know the central bank’s policy reaction function and its
formal or informal analytical model, they can anticipate the monetary policy
response to a given fiscal action and adjust the action accordingly. In
principle, coordination between monetary and fiscal policy can thus be achieved
without negotiations between the monetary and the fiscal authorities, and the
central bank can take advantage of being the first mover (by establishing a
credible reaction function), which is important to avoid undermining its price
stability objective. To implement this approach, it will still be useful if the
central bank and the government can establish a culture of no surprises, to
assist each other in staying the course in spite of a myriad of daily
challenges.
Macroeconomic Management Challenges
In
low-income countries the dependence on selected commodity exports can make them
highly susceptible to terms-of-trade shocks, the predominant role of the
primary sector can lead to large fluctuations in output, demand and government
revenues (in part simply as a result of fluctuations in the weather), and the volatility of aid flows can be a further
huge challenge in trying to stabilize output. In addition, if market
imperfections are such that monetary policy can have permanent effects on real
variables, the central bank may be subject to yet more political pressures.
These factors and a scarcity of reliable statistics and analytical models may
require very close interaction between monetary
and fiscal authorities. This in
turn puts a premium on well considered government arrangements.
Sole Supplier of Money
The Central
Bank is the banker to the banks and is the sole supplier of liquidity (or
reserves) to these banks. A part of the reserves is supplied while performing
central banking functions other than monetary policy operations and constitute
the autonomous drivers of liquidity. These functions include government cash management, meeting currency
demand of the public and foreign exchange management. Thus, in its role as
the banker to the government, the Central Bank’s cash management operations
involve provision of liquidity to tide over temporary deficit of the government
as also facilitate investment of the temporarily surplus cash balances of the government.
Conclusion: The Brussels conference resolution of
1920 was to the effect that "banks, especially banks of issue, should be
freed from political pressure and should be conducted solely on the lines of
prudence." This trend has been reflected in the central banking statutes
relating to ownership of capital, participation in administration, and
intervention in monetary policy.