Functions of the Central Bank

Central bank is regarded as an apex financial institution in the banking system. It is considered as an integral part of the economic and financial system of a nation. The central bank functions as an independent authority and is responsible for controlling, regulating and stabilising the monetary and banking structure of the country.

In India, the Reserve Bank of India is regarded as the central bank. It was set up in 1935. Central banks are responsible for maintaining the financial stability and economic sovereignty of the country.

Also see: Difference Between Central Bank and Commercial Bank

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

1. Currency regulator or bank of issue

2. Bank to the government

3. Custodian of Cash reserves

4. Custodian of International currency

5. Lender of last resort

6. Clearing house for transfer and settlement

7. Controller of credit

8. Protecting depositors interests

The above mentioned functions will be discussed in detail in the following lines.

Currency regulator or bank of issue: Central banks possess the exclusive right to manufacture notes in an economy. All the central banks across the world are involved in issuing notes to the economy.

This is one of the most important functions of the central bank in an economy and due to this the central bank is also known as the bank of issue.

Earlier all the banks were allowed to publish their own notes which resulted in a disorganised economy. To avoid this situation the government around the world authorised the central banks to function as the issuer of currency, which resulted in uniformity in circulation and balanced supply of money in the economy.

Bank to the government: One of the important functions of the central bank is to act as the bank to the government. The central bank accepts deposits and issues funds to the government. It is also involved in making and receiving payments for the government. Central banks also offer short term loans to the government in order to recover from bad phases in the economy.

In addition to being the bank to the government, it acts as an advisor and agent of the government by providing advice to the government in areas of economic policy, capital market, money market and loans from the government.

In addition to that, the central bank is instrumental in formulation of monetary and fiscal policies that help in regulation of money in the market and controlling inflation.

Custodian of Cash reserves: It is a practice of the commercial banks of a country to keep a part of their cash balances in the form of deposits with the central bank. The commercial banks can draw that balance when the requirement for cash is high and pay back the same when there is less requirement of cash.

It is for this reason that the central bank is regarded as the banker’s bank. Central bank also plays an important role in the credit creation policy of commercial banks.

Custodian of International currency: An important function of the central bank is to maintain a minimum balance of foreign currency. The purpose of maintaining such a balance is to manage sudden or emergency requirements of foreign reserves and also to overcome any adverse deficits of balance of payments.

Lender of last resort: The central bank acts as a lender of last resort by providing money to its member banks in times of cash crunch. It performs this function by providing loans against securities, treasury bills and also by rediscounting bills.

This is regarded as one of the most crucial functions of the central bank wherein it helps in protecting the financial structure of the economy from collapsing.

Clearing house for transfer and settlement: Central bank acts as a clearing house of the commercial banks and helps in settling of mutual indebtedness of the commercial banks. In a clearing house, the representatives of different banks meet and settle the inter bank payments.

Controller of credit: Central banks also function as the controller of credit in the economy. It happens that commercial banks create a lot of credit in the economy that increases the inflation.

The central bank controls the way credit creation by commercial banks is done by engaging in open market operations or bringing about a change in the CRR to control the process of credit creation by commercial banks.

Protecting depositors interests: Central bank also needs to keep an eye on the functioning of the commercial banks in order to protect the interests of depositors.

Also check: 

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)

This concludes our article on the topic of Functions of the Central Bank, which is an important topic in Economics for Commerce students. For more such interesting articles, stay tuned to BYJU’S.

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  1. Thank you this answer is very easy to learn