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The article outlines the primary functions of a central bank, specifically the Reserve Bank of India, which are essential for a country's economic stability. These functions include issuing currency, acting as a banker to the government, managing cash reserves, and controlling credit among others. The central bank plays a crucial role in maintaining the banking system's integrity and protecting depositors' interests.

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11 views

Functions_of_Central_Bank

The article outlines the primary functions of a central bank, specifically the Reserve Bank of India, which are essential for a country's economic stability. These functions include issuing currency, acting as a banker to the government, managing cash reserves, and controlling credit among others. The central bank plays a crucial role in maintaining the banking system's integrity and protecting depositors' interests.

Uploaded by

andrew kachere
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Functions of Central Bank

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37.2k views
5 min read
Updated on Jun 12, 2023

Rashmi KaranManager Content504 Blogs written

The article discusses about the primary functions of central bank and
explains why those functions are crucial for uplifting a country’s economy.

A country has only one central bank. In India, it is the Reserve Bank of India
or RBI. The functions of central bank are crucial and they form the backbone
of the banking system of any country. The central banks perform eight
significant functions in an economy, which are –

Functions of Central Bank


Listed are some of the crucial functions of the Central Bank.

 Bank of Issue
 Banker, Agent, and Advisor to the Government
 Custodian of Cash Reserves
 Custodian of Foreign Balances
 Lender of Last Resort
 Clearing House
 Controller of Credit
 Protection of Depositor’s Interests

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1. Bank of Issue
Central bank nowadays has a monopoly over issuing notes in every country.
In India, RBI is responsible for printing and issuing currency notes.

A single bank is given the exclusive monopoly of notes to ensure uniformity,


better control, and simplicity. It will also ensure that no individual bank is
over-issuing the notes.

The central banks, thus, regulate the country’s currency and the economy’s
total money supply. The central bank keeps gold, silver, or other securities
like properties against the notes issued. The system of note-issue varies from
country to country.

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2. Banker, Agent, and Advisor to the Government


The RBI in India performs the functions of a banker, agent, and adviser to the
government. It ensures a safe and intimate connection between public
finance and monetary affairs while being convenient and economical.

Central banks also perform the below functions as a banker to the


government –

 Receives and makes payments for the government


 Allocates short-term loans to the government in case of emergencies
 Floats public loans and manages public debts
 Maintains the banking accounts and balances of the government after
disbursements and remittances
 Advises the government on economic matters
 Act as a government agency where general exchange control is in force

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3. Custodian of Cash Reserves


Commercial banks of a country keep a part of their cash balances in the form
of deposits with the central bank as a legal compulsion or convention. They
draw the cash balances during busy seasons and pay them back during low
seasons. These balances are used for clearing purposes. The central banks
also help and guide other member banks in need.

It affects the centralization of cash reserves of the member banks. These


centralized cash reserves form the base of a vast and flexible credit
structure. Suh cash reserves would not be useful if scattered amongst the
individual banks.
It is evident when bank reserves are pooled in one institution, which is,
moreover, charged with safeguarding the country’s economic interests. Such
reserves can be used to the fullest extent and most effectively during
seasonal strain, financial crises, or general emergencies. The centralization of
cash reserves is conducive to the economy in their use and increased
elasticity and liquidity of the banking system.

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4. Custodian of Foreign Balances


The central bank is responsible for securing the stability of the exchange rate
under the gold standard.

After World War I, central banks kept gold and foreign currencies as reserve
note-issue and met the adverse balance of payment with other countries
whenever needed. The central bank also maintains the exchange rate fixed
by the government and manages exchange control and other restrictions
imposed by the state. Thus, it becomes a custodian of the nation’s
international currency reserves or foreign balances.

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5. Lender of Last Resort
The central bank helps the member banks strengthen their cash reserve
position by rediscounting first-class bills in emergencies. Member banks can
also take money or credit on approved short-term securities. These banks
can then add this amount to their cash resources quickly. This way, the
member banks can turn their assets into cash on short notice. Such a process
promotes elasticity and liquidity in the banking and credit system economy.

Thus, we can say that the central bank is responsible for meeting commercial
banks’ urgent and reasonable demands for accommodation.

According to Sir Ralph George Hawtrey, the essential duty of the central bank
as the lender of last resort is to make a cash shortage among the competitive
banks.

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6. Clearing House
The central bank is a banker’s bank that keeps the cash balances of
commercial banks and helps the member banks. It is also responsible for
settling the accounts of commercial banks. Its function is that of a clearing
house, an organization where the banks can offset the mutual claims against
one another and make a settlement by paying the difference.

Let us understand this through an example –

Suppose there are two banks. They draw cheques on each other. Suppose
bank A has Rs. 10,000 from bank B and is obligated to pay Rs. 12,000 to
bank B. At the clearing house, they can offset the mutual claims, where bank
A pays off Rs. 2,000 to bank B, and the account is settled. The central bank’s
clearinghouse contributes to the economy through cash, avoiding hectic
communications and inconvenience.

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7. Controller of Credit
Money and credits can play a huge role in determining income and
employment levels. Currency expansion or contraction can lead to business
fluctuations. Credit control is essential since commercial banks generate a lot
of credit, resulting in higher inflation.

The central bank is also responsible for controlling or overseeing commercial


banks’ credit adjustment.

Central banks can influence the deposits of commercial banks by performing


open market operations and changing CRR to control various economic
conditions. This control of the central bank over commercial banks, as
regards their deposits, is called the controller of credit.

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8. Protection of Depositor’s Interests


The central bank supervises the functioning of commercial banks to protect
the interest of the depositors and ensure the development of banking on
sound lines.

The banking business has, therefore, been recognized as a public service


necessitating legislative safeguards to prevent bank failures.

The central bank is authorized to inspect commercial banks to ensure an


efficient banking system with sufficient financial resources operating under
proper management in accordance with the banking laws and regulations.

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