CHAPTER # 06

A central bank is a banking institution granted the exclusive privilege to a lend a government its currency. It charges interest on the loans made to borrowers, primarily the government of whichever country the bank exists for, and to other commercial banks, typically as a 'lender of last resort'. It has a monopoly on creating the currency of that nation, which is loaned to the government in the form of legal tender. It is a bank that can lend money to other banks in times of need.

1-Sole right of note issue

The Central Bank in every country, now, has the monopoly note issue. The issue of notes is governed by certain regulation which is enforced by the state.

2-Banker to the state

A Central Bank acts as a banker to the government. It holds cash balances of the government free of interest.

3-Banker's bank.

The central bank acts as a banker to the commercial banks.

4-Banker's clearing house

The Central Bank acts as a clearing house for the settlement of mutual obligations of different commercial banks. If a difference exists, it is paid by a cheque drawn on the banks accounts carried at the Central Bank.

5-Lendor to the last resort

The Central Bank helps the member banks in times of crisis.

6-Financial agent

The Central Banks act as financial agents for the government. It is an agent for the government in purchasing and selling of gold and foreign exchange.

7-Effective monetary policy

The aim of the government is to create employment in the country, resist undue inflation and achieve a favorable balance of payment.

8-External functions

The Central Bank also performs a number of external functions.

9-Maintaining the gold and currency reserves

The Central bank also holds onto the gold reserves of the country and foreign currencies

10-Issue and redemption of Government stocks

The Bank is responsible for issuing, recording ownership and paying the interest on government stocks

11-Treasury Bill Tender

The Bank receives bids for the week’s issue of Treasury Bills and is responsible for allocating the bills to the highest bidders

12-Operating the Exchange Equalization Account

The Central Bank also is responsible for buying and selling sterling, due to which it also takes care of this account

Advances become deposits The size of multiplier

Interest rates Open Market Operations Special Deposits Other Weapons

By far the most visible and obvious power of many modern central banks is to influence market interest rates

If interest rates are raised then borrowing is discouraged and thus the credit creation process is slowed down, and opposite will happen due to lower interest rates

Through open market operations, a central bank influences the money supply in an economy directly. Each time it buys securities, exchanging money for the security, it raises the money supply. Conversely, selling of securities lowers the money supply. Buying of securities thus amounts to printing new money while lowering supply of the specific security.

In order to reduce the ability of the banks to lend by way of loans and overdrafts, a call for special deposits is made by the Central bank

When special deposits are repaid they have opposite effect upon the liquidity of the Banks

Reserve assets ratio Qualitative directives Quantitative directives