IndianTechnoEra: Central Banks its Types and Functions | IndianTechnoEra

 

What is Central Bank?

Doesn’t directly deal with general public.

Regulate other banks functions.

A lender of last resort.

Central Banks its Types and Functions | IndianTechnoEra

Responsible for controlling inflation, rate of interest and monetary policy among other necessary functions in an economy.

Central Bank Definition: 

“A Central Bank is the bank in any country to which has been entrusted the duty of regulating the volume of currency and credit in that country” -Bank of International Settlement.

 According to Kent : “Central Bank may be defined as an institution which is charged with the responsibility of managing the expansion and contraction of the volume of money in the interest of general public welfare.” 

Ex: RBI, 

RBI - Reserve Bank of India

RBI - Reserve Bank of India | IndianTechnoEra

It is the central bank of India. 

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. 

It was originally constituted with a capital of Rs.5crores.The entire share capital was contributed privately with the exception of the nominal value of Rs 2.2 lakh subscribed by the central bank. 

After independence, the reserve bank of India was nationalized.

Management Structure of Reserve Bank of India

Management Structure of Reserve Bank of India | IndianTechnoEra

Objectives Of R.B.I 

• 1.To manage the monetary and credit system of the country. 
• 2.To stabilizes internal and external value of rupee. 
• 3.For balanced and systematic development of banking in the country. 
• 4.For the development of organized money market in the country.
• 5. For proper arrangement of agriculture finance. 
• 6.For proper arrangement of industrial finance. 
• 7.For proper management of public debts 
• 8. To establish monetary relations with other countries of the world and international financial institutions. 
• 9.For centralization of cash reserves of commercial banks. 
• 10. To maintain balance between the demand and supply of currency.

Function of central bank

The functions of a central bank can be discussed as follows:

• Currency regulator or bank of issue 
• Bank to the government 
• Custodian of Cash reserves 
• Custodian of International currency 
• Lender of last resort 
• Clearing house for transfer and settlement 
• Controller of credit 
• Protecting depositor’s interests 
• Functions of central banks are as below: 
• Regulator of currency 
• Banker, Agent and Adviser to the Government 
• Custodian of cash Reserves of commercial banks 
• Custodian and Management of Foreign Exchange reserves 
• Lender of the last resort 
• Clearing house Function 
• Controller of credit

Some Other Functions of Central Bank

• Traditional Functions :  Which are generally performed by central banks all over the world, are classified into two groups; 
• Primary Functions: including issue of notes, regulation of financial system, and conduct of monetary policy 
• Secondary Functions: including management of public debt, management of foreign exchange, advising the government on policy matters, and maintaining close relationships with the international financial institutions .
• Non-Traditional Functions: these functions are performed by the Central Bank include development of financial frame work, provision of training facilities to bankers, and provision of credit to priority sectors.

What is the means Regulator of currency?

The issue of paper money is the most important function of a central bank. The central bank is the authority to issue currency for circulation, which is a legal tender money. The issue department of the central bank has the responsibility to issue notes and coins to the commercial banks. The central bank regulates the credit and currency according to the economic situation of the country. In the methods of note issue, the central bank is required to keep a certain amount or a fixed proportion of gold and foreign securities against the total notes issued. The Reserve Bank of India is required to keep Rs.115 crore in gold and Rs.85 crore in foreign securities, but there is no limit to the issue of notes. Having the monopoly of note issue, central bank gains advantages as Ensuring uniformity of the notes issued and a proper control over the supply of money can be exercised. Bring stability in the monetary system and creates confidence among the public. Government is able to earn profits from printing currencies.

What is the meaning of Banker, Agent and Adviser to the Government?

The central bank of the country acts as the banker, fiscal agent and advisor to the government. As a banker, it keeps the deposits of the central and state governments and makes payments on behalf of governments. It buys and sells foreign currencies on behalf of the government. It keeps the stock of gold of the country. As a fiscal agent, the bank makes short-term loans to the government for a period not exceeding 90 days. It floats loans and advances to the State governments and local bodies. It manages the entire public debt on behalf of the government. As an adviser, the bank gives useful advice to the governments on important monetary and economic problems like devaluation, foreign exchange policy and budgetary policy.

What is the meaning of Custodian of cash Reserves of commercial banks

Commercial banks are required to keep a certain percentage of cash reserves with the central bank. On the basis of these reserves, the central bank transfers funds from one bank to another to facilitate the clearing of cheques . 

What is the meaning of Custodian and Management of Foreign Exchange reserves 

The central bank keeps and manages the foreign exchange reserves of the country. It fixes the exchange rate of the domestic currency in terms of foreign currencies. If there are any fluctuations in the foreign exchange rates, it may have to buy and sell foreign currencies in order to minimize the instability of exchange rates.

What is the meaning of Lender of the last resort 

By giving accommodation in the form of re-discounts and collateral advances to commercial banks, bill brokers and their financial institutions, the central bank acts as the lender of the last resort. The central bank lends to such institutions in order to help them when they are faced with difficult situations so as to save the financial structure of country from collapse. 

What is the meaning of Clearing House Function 

The central bank acts as a 'clearing house' for other banks and mutual obligations are settled through the clearing system. Since it holds cash reserves of commercial banks, it is easier for the central bank to act as a 'clearing house'.

What is the meaning of Controller of credit 

The most important function of the central bank is to control the credit creation power of commercial banks in order to control inflationary and deflationary pressures within the economy. Controlling credit in the economy is amongst the most important functions of the Reserve Bank of India. 

Other Central Bank Functions 

Besides the above functions, the central bank performs many additional functions. It has to study all problems relating the 

• Credit
• Fluctuations in price level 
• Fluctuations in foreign exchange value. It has to collect monetary and financial statistics, conduct research and provide information. It has to look after the matters relating to IMF and the World Bank. All together, the central bank is the financial and monetary guardian of the nation.

Examples of Central Banks

Some of the well known central banks across the world are:

• 1. Federal Reserve (USA) 
• 2. Reserve Bank of India (India) 
• 3. People’s Bank of China (China) 
• 4. Bank of England (UK) 
• 5. European Central Bank (EU or European Union)

The basic and important needs of credit control in the economy

• 1.To encourage the overall growth of the "priority sector" i.e. those sectors of the economy which is recognized by the government as "prioritized" depending upon their economic condition or government interest. 
• 2.To keep a check over the channelization of credit so that credit is not delivered for undesirable purposes. 
• 3. To achieve the objective of controlling inflation as well as deflation.
• 4.To boost the economy by facilitating the flow of adequate volume of bank credit to different sectors. 
• 5. For this purpose, the central bank adopts 

Central Bank Adopts Methods

1. Quantitative methods 

2. Qualitative (selective) methods.

Quantitative Method

These help the quantity of credit created and the money in circulation the following method are used : 

The quantitative measures of credit control are as follows: 

• 1. Bank Rate Policy The bank rate is the Official interest rate at which RBI rediscounts the approved bills held by commercial banks. For controlling the credit, inflation and money supply, RBI will increase the Bank Rate. 
• 2. Open Market Operations These refer to direct sales and purchase of securities and bills in the open market by Reserve bank of India. The aim is to control volume of credit. 
• 3. Varying Interest Rates: Commercial banks vary interest rates depending on the credit requirements of the society and as per directions of RBI
• 4. Varying Reserve Requirements: The central bank changes the rate of cash reserve and it has direct effect on money supply .
• CRR refers to that portion of total deposits in commercial Bank which it has to keep with RBI as cash reserves. an increase in CRR will decrease the capacity of banks to lend money thereby decrease the money supply and vice versa . 
• SLR refers to that portion of deposits with the banks which it has to keep with itself as liquid assets(Gold, approved govt. securities etc.)
• If RBI wishes to control credit and discourage credit it would increase CRR & SLR.
• 5. Varying Repo Rate and Reverse 

What is repo rate?

Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation. 

What is Reverse repo?

Qualitative (Selective) Method

The important qualitative or selective methods of credit control are; (a) Marginal Requirements, (b) Regulation of Consumer Credit, (c) Credit Rationing, (d) Moral Suasion and (e) Direct Action.

Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. It is a monetary policy instrument which can be used to control the money supply in the country.

Limitations of the working of RBI

• 1. Lack of a well organized and well integrated money market.
• 2. Stability in the internal and external value of the rupee has not been maintained. 
• 3. The Reserve Bank of India is not as yet a Completely Autonomous Institution. 
• 4. The unorganized money market of India is still out of the control of RBI

Differences of Central Bank and Commercial Bank