CHAPTER # 06

THE CENTRAL BANK

CENTRAL BANK
A central bank is a banking institution granted the exclusive privilege to a lend a government its currency. It charges interest on the loans made to borrowers, primarily the government of whichever country the bank exists for, and to other commercial banks, typically as a 'lender of last resort'. It has a monopoly on creating the currency of that nation, which is loaned to the government in the form of legal tender. It is a bank that can lend money to other banks in times of need.

FUNCTIONS OF CENTRAL BANK

1-Sole right of note issue The Central Bank in every country, now, has the monopoly note issue. The issue of notes is governed by certain regulation which is enforced by the state.

FUNCTIONS OF CENTRAL BANK

2-Banker to the state A Central Bank acts as a banker to the government. It holds cash balances of the government free of interest.

FUNCTIONS OF CENTRAL BANK

3-Banker's bank. The central bank acts as a banker to the commercial banks.

FUNCTIONS OF CENTRAL BANK

4-Banker's clearing house The Central Bank acts as a clearing house for the settlement of mutual obligations of different commercial banks. If a difference exists, it is paid by a cheque drawn on the banks accounts carried at the Central Bank.

FUNCTIONS OF CENTRAL BANK

5-Lendor to the last resort The Central Bank helps the member banks in times of crisis.

FUNCTIONS OF CENTRAL BANK

6-Financial agent The Central Banks act as financial agents for the government. It is an agent for the government in purchasing and selling of gold and foreign exchange.

FUNCTIONS OF CENTRAL BANK

7-Effective monetary policy The aim of the government is to create employment in the country, resist undue inflation and achieve a favorable balance of payment.

FUNCTIONS OF CENTRAL BANK

8-External functions The Central Bank also performs a number of external functions.

FUNCTIONS OF CENTRAL BANK

9-Maintaining the gold and currency reserves The Central bank also holds onto the gold reserves of the country and foreign currencies

FUNCTIONS OF CENTRAL BANK

10-Issue and redemption of Government stocks The Bank is responsible for issuing, recording ownership and paying the interest on government stocks

FUNCTIONS OF CENTRAL BANK

11-Treasury Bill Tender The Bank receives bids for the weeks issue of Treasury Bills and is responsible for allocating the bills to the highest bidders

FUNCTIONS OF CENTRAL BANK

12-Operating the Exchange Equalization Account The Central Bank also is responsible for buying and selling sterling, due to which it also takes care of this account

CREDIT CREATION
Advances become deposits The size of multiplier

WEAPONS OF CENTRAL BANK

Interest rates Open Market Operations Special Deposits Other Weapons

INTEREST RATES
By far the most visible and obvious power of many modern central banks is to influence market interest rates If interest rates are raised then borrowing is discouraged and thus the credit creation process is slowed down, and opposite will happen due to lower interest rates

OPEN MARKET OPERATIONS

Through open market operations, a central bank influences the money supply in an economy directly. Each time it buys securities, exchanging money for the security, it raises the money supply. Conversely, selling of securities lowers the money supply. Buying of securities thus amounts to printing new money while lowering supply of the specific security.

SPECIAL DEPOSITS
In order to reduce the ability of the banks to lend by way of loans and overdrafts, a call for special deposits is made by the Central bank When special deposits are repaid they have opposite effect upon the liquidity of the Banks

OTHER WEAPONS
Reserve assets ratio Qualitative directives Quantitative directives