What is central bank? Its functions

Central bank occupies an important place in the monetary and banking system of every country. It is the apex bank of a country. In case of Under Developed countries, it is instrumental in the process of growth. It is the sole agency of note-issue in a country.

In India, Reserve Bank, In England, Bank of England and In America, Federal Reserve System operate as central banks.

DEFINITION

According to Prof. Samuelson" Every Central Bank has one function. It operates to control economy, supply of money and credit."

FUNCTIONS

The functions of Central bank are as under:-

1) ISSUING OF NOTES:-

Central bank now-a-days has the monopoly of note-issue in every country. The currency notes printed and issued by the central bank are declared unlimited legal tender throughout the country. It has been given exclusive monopoly of note-issue in the interest of uniformity, better control, elasticity, supervision, and simplicity. It will also avoid the possibility of over-issue by individual banks.

2) BANKER TO THE GOVERNMENT:-Central bank, everywhere, performs the functions of banker, agent and adviser to the government.As banker to the government, it makes and receives payments on behalf of the government. It advances short-term loans to the government to tide over difficulties.It floats public loans and manages the public debts on behalf of the government. It keeps the banking accounts and balances of the government after making disbursements and remittances. As an adviser to the government it advises the government on all monetary and economic matters. The central bank also acts as an agent to the government where general exchange control is in force.

3) BANKER'S BANK:- It performs the function of a banker to all other banks in the country. Central Bank has almost the same relation with all other banks as an ordinary bank has with its customers. It keeps part of the cash balance of all commercial banks as deposit with a view to meeting liabilities of these banks in times of crisis.Initially, keeping of the cash balances or reserves with the Central Bank was voluntary on the part of commercial banks, but now, in almost all countries of the world such cash reserves have been made statutory.

4) LENDER OF LAST RESORT:- Central bank is the lender of last resort, for it can give cash to the member banks to strengthen their cash reserves position by rediscounting first class bills in case there is a crisis or panic which develops into ‘run’ on banks or when there is a seasonal strain. Member banks can also take advances on approved short-term securities from the central bank to add to their cash resources at the shortest time.

This facility of turning their assets into cash at short notice is of great use to them and promotes in the banking and credit system economy, elasticity and liquidity.

Thus, the central bank by acting as the lender of the last resort assumes the responsibility of meeting all reasonable demands for accommodation by commercial banks in times of difficulties and strains.

5) CUSTODIAN OF THE NATION'S RESERVES OF FOREIGN EXCHANGE:- Under the gold standard or when the country is on the gold standard, the management of that standard, with a view to securing stability of exchange rate, is left to the central bank.

After World War I, central banks have been keeping gold and foreign currencies as reserve note-issue and also to meet adverse balance of payment, if any, with other countries. It is the function of the central bank to maintain the exchange rate fixed by the government and manage exchange control and other restrictions imposed by the state. Thus, it becomes a custodian of nation’s reserves of international currency or foreign balances.

6) CLEARING HOUSE FUNCTION:- Central bank also acts as a clearing house for the settlement of accounts of commercial banks. A clearing house is an organisation where mutual claims of banks on one another are offset, and a settlement is made by the payment of the difference. Central bank being a bankers’ bank keeps the cash balances of commercial banks and as such it becomes easier for the member banks to adjust or settle their claims against one another through the central bank.

Suppose there are two banks, they draw cheques on each other. Suppose bank A has due to it Rs. 3,000 from bank B and has to pay Rs. 4,000 to B. At the clearing house, mutual claims are offset and bank A pays the balance of Rs. 1,000 to B and the account is settled. Clearing house function of the central bank leads to a good deal of economy in the use of cash and much of labour and inconvenience are avoided.

7) CONTROL OF CREDIT:- The control or adjustment of credit of commercial banks by the central bank is accepted as its most important function. Commercial banks create lot of credit which sometimes results in inflation.

The expansion or contraction of currency and credit may be said to be the most important causes of business fluctuations. The need for credit control is obvious. It mainly arises from the fact that money and credit play an important role in determining the level of incomes, output and employment.

According to Dr. De Kock, “the control and adjustment of credit is accepted by most economists and bankers as the main function of a central bank. It is the function which embraces the most important questions of central banking policy and the one through which practically all other functions are united and made to serve a common purpose.”

Thus, the control which the central bank exercises over commercial banks as regards their deposits, is called controller of credit.