Functions of Central Bank

A central bank is fundamentally a chief bank of a nation. The essential responsibilities of the central bank include issuing and maintenance of stable influx of currency, keeping inflation under control and ensuring optimum employment. Other tasks of the central bank consists of holding deposits on the reserves of other banks, as well as overseeing lending and exchange practices of commercial banks.

Central bank is the monetary authority of a country. It maintains the price stability through economic and monetary policy measures, meaning the country’s foreign exchange and the gold reserve and regulating the banking sector of the country. The central bank is both the Government’s banker and the banker’s bank, a “Lender of the last Resort”. It exercises monopoly over the issue of currency and the banknotes. Detail functions of central bank are given below:

1. Note Issue: Central bank is the sole authority for issuance of bank notes in the country. This power enables the bank to regulate and control money supply in the country.

2. Banker to the Government: Being at the hub of financial activities central bank traditionally act as the banker, agent and adviser to the Government. It maintains banking accounts of the Government and its various organs, it makes temporary advances to the Government, carries out the Government’s transactions involving purchases or sales of foreign currencies. Generally, central bank is given remuneration for transacting Government business.

3. As Banker’s Bank: Traditionally central bank serves as banker to the banks. The commercial banks of a country maintain accounts and entrust their surplus funds with their central bank. They borrow money from it when necessary. At the same time, schedule banks are allowed rediscounting facilities from central bank against government securities and trade bills for a short term to enable them to meet their temporary requirements of fund.

4. Policy Maker: Some times, the central bank’s control over money supply may be undermined by the commercial bank’s mechanism of credit creation. The total amount of money in circulation has a relationship with the creation of credit. Of course, commercial bankers are not the only people having the power. The modern credit cards, debit cards and other forms of electronic money play a part in creation of money. Central bank exercises credit control through various methods in the following ways:

a)    Bank Rate Policy: It involves the variation of discount rates to influence the market rates of interest, which play a crucial role in creation of credit. Whenever central bank wants to reduce credit, the bank rate is raised and whenever the volume of bank credit is to be expanded the bank rate is lowered.

b)    Open Market Operation: It involves purchase and sale of securities, government or central banks own obligation in the open market to influence the quantum of the money circulation.

c)   Variable Reserve System: It involves the variation of the minimum reserves, which the commercial banks are required to keep with the central bank, to curtail or enlarge the power of the commercial banks to create credit.

d)    Selective Credit Control: This method involves directional control to influence the flow of credit in particular channels.

e)  Credit Rationing: Under this method, the central bank, during the time of monetary stringency, rations credit by limiting the amount of credit available to each applicant and restricting re-discount facilities to short term bills. It may also involve setting limits on the individual bank’s credit during a specified period.

f)    Margin Restriction: Under this method central bank set the level up to which the bank would provide finance for the underlying goods, services or the project. In relation to letter of credit the margin restriction implies rates of margin a bank should retain before the letter of credit is opened.

5. Lender of the last Resort: It means a lender to whom borrowers may approach when all other lending sources have failed. This is the characteristic function of central bank who is the last resort for the commercial banks to approach for accommodation when there is a shortage of funds in the market.

6. Custodian of National Reserve: Central bank is entrusted with the custody of the nations reserves. The reserves in the past were mainly kept in the form of gold but after the breakdown of gold standard currently convertible foreign currencies form the back-bone of reserve assets. Central bank also works as custodian of foreign reserves.

7. Bank of Central Clearance: Being the holder of the balances of the commercial banks, central bank is specially qualified to act as a bank of central clearance. It promotes and run the clearance system in the cities and towns where it has branches.

8. Exchange Control: Being responsible for the maintaining the exchange value of money notes central bank also administers exchange control in the country. This task is two fold. On the one hand, it ensures that all foreign exchange receipt are accounted for and surrendered to the authorized dealers. On the other hand, it allocates and rations foreign exchange in line with set priorities.   

9. Licensing Authority: No bank can commerce banking in a country and no existing bank can open a new branch in or outside the country or shift any branch from one place to another without obtaining a license or permission form central bank.

10. Credit Information Bureau: With a view to strengthening credit discipline and streamlining all sorts of data in a symmetric way for formulation of monetary, economic and credit policy, a full fledged credit information bureau is functioned by central bank.

From the above discussion, we can understand that central bank’s activities are running for the goodness and betterment of banking, economic development, making policies, doing job for the Government, making rules and regulations for banks and financial organizations, controlling the money market and social development works.