Functions of Central Bank PDF

Functions of Central Bank Central Bank The central bank is the apex institution of a country’s monetary system. The design and control of the country’s monetary policy is its main responsibility. India’s central bank is the Reserve Bank of India. Functions of Central Bank 1) Currency Authority The...

Functions of Central Bank Central Bank The central bank is the apex institution of a country’s monetary system. The design and control of the country’s monetary policy is its main responsibility. India’s central bank is the Reserve Bank of India. Functions of Central Bank 1) Currency Authority The central Bank is the sole authority for the issue of currency in the country. This is to- 1) Maintain uniformity in currency 2) Have control of money supply 3) Avoid fake currency 2) Banker to the government 1) The central bank acts as the banker to the government of the country. 2) It keeps the cash balances of the government and maintains its accounts. 3) It gives advances to the government and also takes the responsibility of the sale of government securities. 4) It also manages public debt and gives advice to the government on various financial matters. 3) Bankers Bank and supervisor 1) As the banker to banks, the Central Bank holds a part of the cash reserves of banks, lends them short term funds and provides them with centralized clearing and remittance facilities. 2) Central bank acts as the banker to the banks in three ways: (i) custodian of the cash reserves of the commercial banks; (ii) as the lender of the last resort; and (iii) as clearing agent. a) Custodian of cash reserves:- Commercial banks are supposed to keep a certain proportion of cash reserves with the central bank (CRR). b) Lender of last resort: - When commercial banks fail to meet their financial requirements from other sources, they approach Central Bank which gives loans and advances. c) Clearing house: - Since the Central Bank holds the cash reserves of commercial banks it is easier and more convenient to act as clearing house of commercial banks. 4) Custodian of foreign exchange reserves 1) Central Bank is the custodian of foreign exchange reserves. Central Bank acts as custodian of country’s stock of gold and foreign exchange reserves. 2) It helps in stabilizing the external value of money and maintaining favourable balance of payments in the economy. 5) Controller of Money Supply and Credit The Central Bank controls the money supply and credit in the best interests of the economy by quantitative and qualitative instruments. Central bank has power to regulate the credit creation by commercial banks. I) Quantitative Instrument A. Rates Bank Rate The bank rate is the rate at which the Central Bank lends funds for long term to banks against approved securities or eligible bills of exchange. To increase credit creation Bank rate is reduced and vice versa. Repo Rate It is the rate at which the Central Bank lends to Commercial Banks for short term. To increase credit creation Repo rate is reduced and vice versa. Reverse Repo Rate It is the rate at which the Commercial Banks keep their excess funds with Central Bank. To increase credit creation Reverse Repo rate is reduced and vice versa. B. Ratios Cash Reserve Ratio (CRR) Commercial banks are supposed to keep a certain proportion of their deposits as cash reserves with the central bank. To increase credit creation CRR is reduced and vice versa. Statutory Liquidity Ratio (SLR) Commercial banks are supposed to keep a certain proportion of their deposits in the form of gold and government securities. To increase credit creation SLR is reduced and vice versa. C. Open Market Operations Open market operations is the buying and selling of government securities by the central bank from/to the public and banks on its own account. The sale of government securities to banks will have the effect of reducing their reserves. The purchase of government securities to banks will have the effect of increasing their reserves. For increasing credit creation RBI will start purchasing government securities. For decreasing credit creation RBI will start selling government securities. II) Qualitative Credit Control A. Margin requirement (MR) A margin is the difference between the amount of the loan and market value of the security offered by the borrower against the loan. To increase credit creation MR is reduced and vice versa. B. Moral Suasion This is a combination of persuasion and pressure that the Central Bank applies on the other banks in order to get them to fall in line with its policy. C. Credit Rationing These are used to control the credit. Quota is fixed for different sectors.