Central Banks: Functions and Monetary Policy

• Central banks are typically specific to a single country, such as the Bank of England.
• The European Central Bank is an exception, as it serves a group of countries.

Functions of a Central Bank

• Defining and conducting monetary policy is a key function.
• Central banks monitor and manage all payment systems.
• Acting as a lender of last resort to the banking sector, providing liquidity to prevent financial crises.
• Central banks set interest rate levels.
• Supervising banks to ensure compliance with regulations and maintain solvency ratios.
• Guaranteeing price stability by minimizing inflation and deflation, aiming for around 2% through rates directors.
• Monopolizing the issuance of fiat currency, including coins and banknotes.
• Participating in the management of external monetary relations, determining exchange rate regimes and national currency parity against foreign currencies.
• Serving as the banker and financial agent for the government.

Main Functions of Commercial Banks

• Opening and maintaining current and savings accounts.
• Receiving and administering customer deposits.
• Offering loans and credits to generate profit.
• Managing various types of transactions and transfers, both locally and internationally.
• Issuing checks and cards.
• Marketing financial products like bonds, insurance, and investment plans.
• Providing custody for valuable items and documents.
• Purchasing and selling currencies.
• Issuing letters of credit and letters of guarantee.
• Discounting drafts.

Exchange Rate

• Exchange rate denotes the value (or price) of one national currency compared to another.
• It represents the amount of foreign currency obtainable for one unit of another currency.
• Currency exchange rates are determined in the "exchange market," also known as "Forex."
• The foreign exchange market operates under supply and demand principles.
• Increased demand for a currency in the international exchange raises its price (value).
• Exchange rates fluctuate continuously based on supply and demand dynamics.
• Currency exchange rates can be fixed or floating:
  • In a fixed rate system, the exchange rate is set against a reference currency, often the US dollar or euro.
  • Changes to this fixed rate require a decision by the national authority issuing the currency.
  • In a floating rate system, the exchange rate varies with each transaction, based on supply and demand for each currency in the foreign exchange market.
• In a floating exchange rate system:
  • Official parity decrease is devaluation.
  • Official parity increase is revaluation.
• Most countries adopted the floating rate system in 1973.

Explore the functions of central banks, including monetary policy implementation and oversight of payment systems. Learn about their role as lenders of last resort, interest rate management, and bank supervision. Understand how they ensure price stability and manage currency issuance and external monetary relations.