To understand what is the functions of central bank, firstly we should know about what central bank is? Every country of the world has its own central bank for resolving all the monetary and credit problems in the country. We can define the central bank as “Central bank is an institution, which is charged with the responsibility of managing the expansion and contraction of the volume in the interest of the general public welfare”.
England established her first Central Bank “Bank of England” in 1694. The Federal Reserve System which undertakes banking in United States was organized in 1913. France set up her Central Bank (Bank of France) in 1800. Pakistan established her first central bank (State Bank of Pakistan) on 1948.
Functions of Central Bank
Almost the primary functions of Central Bank in almost every country are same, but some secondary functions of central bank may different from others. De, Kock, an economist has given the following list of the main important functions of central bank.
- It has sole right to issue note.
- It serves as a banker to the state.
- It acts as banker’s bank.
- It is the lender of the last resort.
- It is the guardian of money market.
- It performs the duties of a clearing house.
The primary functions of central bank are given below in details:-
- Monopoly of Note-Issue
In early banking, every bank has the practice of issuing currency notes, which lacking similarity, losing public confidence, causing inflation and ultimately failure of the banks. Hence due to such reasons, this right of issuing currency notes was given only to central bank of the country, everywhere in the world. Now the central bank issues currency notes and maintains their value in the country also regulates them according to the requirements of the country. So, one of the main functions of central bank is to issue currency notes.
- Bankers to the State
Another most important function of central bank is that it acts as a banker to the state or government. It accepts cash deposits and cheques of the government and other incomes of the government like taxes etc and provides cash requirements for payment of salaries, wages and for their expenditure. It maintains the account of government. No interest is paid on the cash balance of the government maintained by the central bank.
- Banker’s Banks
Central bank also performs the duties of banker for other banks of the country. It is also acts as banker’s bank. All the member banks are required to keep prescribed percentage of reserve with the central bank to provide financial protection to the member banks. The ratio of cash reserve can be changed by the state bank if required according to situation. Maintenance of cash reserve also helps in the process of credit control in the country. Against this reserve, central bank helps the member bank in discounting their bill of exchange and supply of cash in financial hardships and other requirements.
- Lender of the Last Resort
Central bank also acts as the lender of the last resort. In difficult time a person can get help from commercial bank. But in case of bank, his financial requirements are fulfilled only by the central bank. Central bank provides financial, accommodation to commercial banks; cooperative banks and other financial institutions in case of financial crises. Central bank helps them either by advancing loans or by discounting bill of exchange held by the commercial banks. This is also one of the important functions of central bank.
- Act as a Guardian
Another function of central bank is that it is the custodian of all resources of country. It controls and regulates the money market of the country. The central bank is vested with the power to control foreign exchange, hence it exercises full control on both the visible and invisible payments from and to the country. Similarly, credit performs the important functions of supplying money in the modern economy. The value of money is influenced by the volume of credit. The volume of credit in the country is regulated for the economic stability. This regulation of credit by the central bank is known as monetary policy or credit control. Controlling credit is also from one of the important functions of central bank.
- Clearing House
Central bank of country also acts as a clearing house for the remember banks. A clearing house is a place where the representatives of commercial banks meet to exchange cheques drawn on each other and then settle the difference owed to the other. It may also be defined as an association of banks to facilitate the exchange, off-set and settlement of credit claims among them and to serves their mutual interest. As every commercial bank keeps a certain percentage of the cash deposits with the central bank, the settlement of inter-bank obligations becomes easy by simple process of book entries. With the help of clearing house, the payments and receipts of large amounts become convenient and secure without involving any cash. The advantage of this system is not only to secure the large amount of payments without risk, loss of time and use of precious metal, but this facility also enables the central bank to carry on the monetary policy of the country more effectively. Clearing house is no doubt is also from one of the important functions of central bank.