Central Bank's Functions

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Money & Banking(The Central Bank & Its Functions)


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Central Bank

A central bank, reserve bank, or monetaryauthority is a public institution that managesa state's currency, money supply, and interestrates.

Central banks also usually oversee thecommercial banking system of theirrespective countries.

In contrast to a commercial bank, a centralbank possesses a monopoly on increasing thenation's monetary base, and usually also

prints the national currency, which usuallyserves as the nation's legal tender.


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Functions of Central Bank

The powers of a central bank, its range offunctions and organizational setup varies fromcountry to country. The main functions of a

central bank are as follows:

a) Sole right of note issue

b) Bankers, Agents and Advisers to the government

c) Banker to commercial banksd) Controller of credit

e) Clearing Agent

f) Lender of the Last resort


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g) Custodian of foreign exchange reserves

h) Development role

i) Other functions

Sole Right of Note Issue

The central bank has the sole monopoly of note issuein almost every country. The currency notes printedand issued by the central bank become unlimited legal

tender throughout the country.The main advantages of giving the monopoly right ofnote issue to the central bank are given below:

It brings uniformity in the monetary system of note

issue and note circulation.


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The central bank can exercise better control over themoney supply in the country.

It increases public confidence in the monetary systemof the country.

It enables the central bank to exercise control over thecreation of credit by the commercial banks.

Bankers, Agents and Adviser to theGovernment

The central bank functions as a banker, agent andfinancial adviser to the government:

As a banker to government

As an Agent to the government

As a financial adviser


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As a banker to government, the central bankperforms the same functions for the government as acommercial bank performs for its customers. Itmaintains the accounts of the central as well as state

government; it receives deposits from government; itmakes short-term advances to the government; itcollects cheques and drafts deposited in thegovernment account; it provides foreign exchangeresources to the government for repaying external debt

or purchasing foreign goods or making other payments.

As an Agent to the government, the central bankcollects taxes and other payments on behalf of thegovernment. It raises loans from the public and thus

manages public debt. It also represents theovernment in the international financial institutions


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As a financial adviser to the lent, the central bankgives advise to the government on economic,monetary, financial and fiscal matters such as deficitfinancing, devaluation, trade policy, foreign exchangepolicy, etc.

Banker to Commercial BanksAs banker to commercial banks, the central bankperforms the following functions:

It holds cash reserves and deposits of commercialbanks.

It rediscounts the bills of exchange of commercialbanks to cover temporary difficulties.

It enables the central bank to influence the creation of


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Controller of Credit

Another important function of the central bank is to controlthe availability and the cost of credit in the country. Bycontrolling credit effectively, the central bank tries to

establish:

Stability in the internal price level of the country

Stability in the exchange rates

The money market

The main instruments which are generally used to controlthe credit are:

Bank rate Open market operations


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Clearing Agent

As the custodian of the cash reserves of the commercialbanks, the central bank acts as the clearing house forthese banks. Since all banks have their accounts with thecentral bank, the central bank can easily settle the claimsof various banks against each other with least use of cash.

It economies the use of cash by banks while settling theirclaims and counter-claims.

It reduces the withdrawals of cash and these enable thecommercial banks to create credit on a large scale.

It keeps the central bank fully informed about the liquidity

position of the commercial banks.


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Lender of the Last ResortIn case the commercial banks are not able to meet theirfinancial requirements from other sources, they can, as alast resort, approach the central bank for financialaccommodation. The central bank provides financialaccommodation to the commercial banks by rediscountingtheir eligible securities and exchange bills.

It increases the elasticity and liquidity of the whole creditstructure of the economy.

It enables the commercial banks to carry on their activitieseven with their limited cash reserves.

It provides financial help to the commercial banks in timesof emergency.

It enables the central bank to exercise its control over


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Custodian of Foreign Exchange ReservesThe central bank acts as a custodian of foreignexchange reserves. As a custodian, it helps the centralbank to,

Correct adverse balance of payments

Check flight of capital from country

Stabilize exchange rates

Paying off external debts

The exchange rate determination


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Development Role

In the developing countries of the world, the centralbank besides performing the traditional functionsmentioned above, also performs developmental andpromotional functions.

The central bank undertakes the responsibility ofeconomic growth with stability in the economy.

It ensures that the available funds flow to the variouspriority sectors such as agricultures, export sector,small scale sector, etc.


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Other Functions

The miscellaneous functions performed by the central

bank are as follows:

It maintains relations with international agencies suchas IMF, World Bank, etc.

It provides training facilities to the staff working invarious banking institutions.

It conducts seminars, surveys and publishes annualreports, giving real economic picture of the economy.


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Central Bank's Functions

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