Functions of Central Bank

The meaning of central bank is a financial institution that has the privilege of producing and distributing money (and credit) for a country or a group of countries. The central bank, in the modern economy, is also responsible for regulating member banks and formulating monetary policies. This article will acquaint you with the importance of the central bank with a focus on the functions of central bank of India.

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Features of Central Bank

The basic nature of Central banks is that they are non market-based and also anti-competitive institutions. The key features of a central bank are:

  • Most central banks are centralized though there could be central banks that are not government agencies.

  • Even if the central government does not own a central bank, the law establishes and protects the privileges of a central bank.

  • It has a legal monopoly status that enables it to issue cash and banknotes as opposed to private commercial banks that can issue only demand liabilities, for example, checking deposits.

Functions of Central Bank

A central bank is deemed as the lender of the last resort, as per Hawtrey ( a British economist). The central bank is that organ of the government which controls major financial operations of the government. Through its various operations, the objectives of the central bank are to support the economic policy of a country by influencing the way financial institutions behave.

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The central bank of India is RBI or Reserve bank of India and it is a statutory bank. The primary role of RBI in India is to print currency notes and manage money supply in the economy of India. Let us now delve into the central bank and its functions where we will discuss the role of central bank in money market:

  • Regulator of Currency - The main function of the central bank is to print currency notes and RBI has the sole right in the country for this operation. RBI prints money of all denominations apart from 1 rupee note. It is the ministry of finance that issues 1 rupee note.

  • Banker and Advisor to the government - This role of central bank is of a fiscal agent to the government where the RBI keeps the deposits of both central and state governments. It also makes payments on behalf of the government, along with buying and selling foreign currencies. The various functions of a reserve bank as an advisor is to tender useful suggestions to the government regarding monetary policies and other economic matters.

  • Custodian of commercial banks - As per law, commercial banks need to keep a reserve that is equal to a certain percentage of the NDTL (net demand and time liabilities). These reserves help commercial banks clear cheques by transferring funds from one bank to another. The resee bank facilitates these transactions as it acts as a custodian and lender of cash reserves to the commercial banks.

  • Custodian and manager of foreign exchange reserves - To keep the rates of foreign exchange stable, the reserve bank buys and sells foreign currencies at international prices. If the supply of foreign currency decreases in the economy, RBI sells them at foreign exchanges, and in case of surplus supply, it buys them. RBI is also an official reservoir of foreign currencies and gold. RBI sells gold to monetary authorities of other countries at fixed prices.

  • Lender of the last resort - The RBI grants accommodation to commercial banks, financial institutions, bill brokers, etc. in the form of collateral advances or re-discounts. This step is taken in times of stress so that the financial structure of the country is saved from collapsing. This lending is done on the basis of government securities, treasury bills, government bonds, etc.

  • Controller of Credit - The Reserve bank of India controls the credit created by commercial banks. The credit flow in the country is regulated by means of two methods; quantitative method and qualitative method. RBI applies tight monetary policies when it observes that there is enough supply of money which may cause an inflationary situation. It squeezes the money supply to keep inflation in check.

  • Transfer and settlements - The central bank acts as a “clearinghouse” by providing free services to commercial banks in transferring and settling their mutual claims. Since the RBI holds reserves of commercial banks, it facilitates the clearing of cheques by transferring funds between banks. The principle of bookkeeping is followed in this procedure to make transfer entries into their accounts. There is a separate department operated by the central bank in big cities and trade centers to transfer and settle the claims of one bank on the other.

Importance of Central Bank

The central bank is the heart of the monetary system of any country. A country’s economy is influenced heavily by the actions taken by its central bank. They are the key governing body that ensures the boom and bust cycle of the economy and financial markets does not hamper the direction of the country’s economy. Its central bank ensures the steady and stable growth of the economy of a country.

FAQs (Frequently Asked Questions)

Q1: Give a Brief History of Central Banks.

Ans: The Bank of England and the Swedish Riksbank were the prototypes of central banks in the world. These banks were established in the 17th century. The Bank of England first acknowledged the role of the central bank as the lender of last resort. Some of the other early central banks are Germany's Reichsbank and Napoleon's Bank of France. These banks were established as the means to finance military operations of the respective countries, which were quite expensive.

The reserve bank of India was nationalized on January 1st, 1949 by the RBI Act 1948. Before RBI, the Imperial Bank of India was performing all the functions of a central bank. The main purpose of the nationalization of RBI was to prevent the centralization of shares in the hands of non-government shareholders.

Q2: What are District Central Cooperative Bank Functions?

Ans: The DCCB or district cooperative central banks are the cooperative banks that operate at the district level in several parts of India. They have the following functions:

  • They fulfil the credit requirements of the member societies.

  • Provide financial and banking support for the livelihood in rural areas, especially the agricultural sector.

  • They act as a balancing center for PACS (Primary Agricultural Credit Societies). There is close and continuous contact between DCCBs and PACS where DCCB provides leadership and guidance support to PACS.

  • They can also perform non-credit activities.