We know Central Bank by a different name in different countries, some call it as Central Bank, Reserve Bank or National Bank or Monetary Authority. 

A Central Bank is an institution which Governs and Regulates the Banking system in the Country. It manages the current money supply, interest rates, issuance currency & coins and management of Foreign Exchange & Reserves.

Central Bank has the Supervisory and Regulatory powers to ensure the smooth functioning of Banks. 

And their day to day operations and checks on their working and if they are following the right policies and discourage reckless or fraudulent behaviour of the Banks.

Central Bank also acts as Banker’s Bank or Lender of last resort to Banks when they need funds or in financial crisis.

Central Banks in most countries act as Independent body though they come under the Government.

Functions and Roles of Central Bank:

  • The Government’s banker and the Bankers’ Bank, also known as “lender of last resort”.
  • Regulator and Supervisor of the Banking Industry.
  • Implementing and Monitoring the Monetary Policies for the Country.
  • Regulating, Controlling and Setting the official Interest Rate and Money Supply in the Country.
  • Managing the Country’s Foreign Exchange, Gold Reserves and the Government Bonds.

Central Banks plays a vital role in any country for its economic development and monitoring. Let’s further discuss these functions of Central Bank in details. 

  • The Government’s banker and the Bankers’ Bank, also known as “lender of last resort”. Central Bank plays the role of banker to the Government and Banker to the Banks in the Country.
  • Central Bank as a Banker to the Government: Central Bank operates and functions as a Banker to the Central and State Governments. All the business activities are carried out by Central Bank and managers the Money of the Government in the form of Cash Balances with them. Central Bank accepts money and makes payment on behalf of the Government. All the Banking operations on behalf of Government are managed and run through Central Bank as they carry out Exchange and Remittance on their behalf. Central Bank also give Loans and Advances to the Government for their short term or temporary requirements. They also manage the Public Debt of the Country.
  • Banker’s Bank and Supervisor: Central Bank is the Regulator and Supervisor of the entire Banking System and Industry. Central Bank plays three significant roles as Banker’s Bank:
  • It is a Custodian of the Cash Reserves: All Banks in the Country require to keep/maintain a certain percentage of their Deposits with Central Bank. It is the holder of the Cash Reserves of these Banks.

Central Banks are the Lenders of Last Resort:

 When Banks are short with funds, they approach Central Bank for Loans.

Central Clearing: 

It also acts as an agent for Central Clearing, Settlements and Transfers of Funds among Banks.

Regulator and Supervisor of the Banking Industry: The objectives of Central Bank as Regulator and Supervisor is to emphasize on the following:

  • Licensing and Supervision: 

Central Bank acts as Regulatory Authority and issues the License to Banks, Supervise, Control and Monitor their operations and conduct as Bank.

  • Maintains Capital and Reserves Requirements of the Banks

Every Bank needs to maintain minimum Capital Requirement and Cash Reserves as per the prescribed policies of the Central Bank from time to time.

  • Risk Minimization: 

Central Bank takes suitable measures for the Banks to reduce the risk level by maintaining safe Credit Policies, Risk of disruption from trading activities.

  • Financial Reporting and Disclosures: 

Central Bank ensures complete transparency in the Banking System as they need to maintain standard reporting systems for Sharing and Disclosing the data as per Central Bank requirements and directives.

  • Detection and Elimination of Fraud Currency:

 Central Bank keeps an eye on money in the system, takes corrective measures; and checks to Detect and Eliminate any means to introduce fake currency.

Implementing and Monitoring the Monetary Policies for the Country: Central Bank Implement and monitor the Monitory Policy by following ways:

Manages Money Supply: Under the Monitory Policy, Central Bank manages the Money Supply in the economy.

Managing Inflation and Price Stability: 

By implementing the Monetary Policy Central Bank ensure Inflation Targeting and Price Stability, Full Employment and Stable Economic Growth.

Reserve Ratio and Interest Rates:

 Central Banks through its Monetary Policy directly affect Money Flow in the economy by way of maintaining Reserve Ratios or Open Market Operations and indirectly affect by using Interest Rates to influence the Cost of Credit.

Market Liquidity and Encourage Economic Activity:

 Central Bank reduces the Cash Reserve Ratio and Interest Rates to create Market Liquidity to Encourage Economic Activity and Growth. Sometimes tight Monetary Policy is required to curb the Inflation in the economy.

Regulating, Controlling and Setting the official Interest Rate and Money Supply in the Country: Central Banks manages and maintains the Monetary Policy for the Country by way of following:

Cash Reserve Ratio (CRR):

 Banks need to keep a certain percentage of their Deposits with Central Bank as Cash Reserve Ratio. Central Bank uses this as a tool to increase or decrease the money liquidity in the economy.

Statutory Liquidity Ratio (SLR): Financial Institutions have to maintain a certain quantity of liquid assets with them in liquid form; to meet any time demands for money and liabilities.

These assets need to be kept in a non-cash way such as Precious Metals, Government Securities and other Securities such as Bonds.

Bank Rate Policy or Discount Rates: Bank Rates are also known as Discount Rates.

It is the rate of interest charged by Central Bank for providing funds or loans to the Banking System and other approved financial institutions. The funds are provided directly through lending or discounting or buying money market instruments like Commercial Bills and Treasury Bills.

The decrease in Bank Rate leads to liquidity and Increase in Bank Rate leads to tightening of cash in the economy.

Credit Ceiling: Central Bank allocates certain limits for lending.

Sometimes these limits are awarded based on some specific sectors such as keeping a certain amount of allocation to Agriculture and Priority Sector.

Repo Rate and Reverse Repo Rate:

Repo Rate” is the rate at which Central Bank lends money to Bank and Financial Institutions. “Reverse Repo Rate” is the rate at which Central Bank borrows the money from Banks and Financial Institutions. Central Bank uses these as a tool to Increase or Decrease the Money flow in the economy.

Managing the Country’s Foreign Exchange, Gold Reserves and the Government Bonds: 

Bank operates the Foreign Exchange & Gold Reserves and Government Bonds

Development of Foreign Exchange Markets: 

The Objective is to manage external trade and payments to promote growth and maintenance of the foreign exchange markets.

Support higher flow of capital in the economy: 

Their policies help the inflow of money in the marketplace, which further help in economic and business development.

Sales and Purchase of Foreign Currency: 

They also participate in the market by undertaking sales and purchase of foreign currency and regulate the market movement to some extent.

Keep Foreign Exchange and Gold Reserves and Government Bonds: 

Central Bank holds them as security and issues new currency against them.

Key Takeaways / Conclusion:

Central Bank plays a vital role and acts as a Bank to Government and works as Independent Authority

It also governs the policies around the Financial markets in the economy, which includes Banks and Financial Institutions.

taking the various decision related to Monetary Policies and Interest Rates, for relaxation or tightening of Money Flow in the Country. Central Banks also regulate Financial Markets, Foreign Exchange market and much more.

About the Author

BankReed Admin

Banking Professional with 16 Years of Experience. The idea to start this Blogging Site is to Create Awareness about the Banking and Financial Services.

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