The document discusses the role and functions of central banking. It begins by defining a central bank and explaining how they evolved from privately owned banks to taking on public functions. It then contrasts central banks with commercial banks and outlines the key functions of central banks, including bank of issue, bank and agent to the state, lender of last resort, and controller of credit. The document also examines various credit control methods used by central banks like bank rate, open market operations, and selective controls. It notes the challenges of central banking in underdeveloped economies.

1. CENTRAL BANKING
 SUBMITTED TO:
 Dr. SUBHASH SHARMA
 SUBMITTED BY:
 LUDARMANI
 REGD. NO (F-15-04-M)

2. CENTRAL BANKING
 CENTRAL BANK
 According to De Kock “Central bank is a bank which constitute
apex of monetory and banking structure”.
 Central banks were started as privately owned and privately managed
joint stock banks, but on account of their influence on economic
activities and their power to control credit, governments shows great
willingness to participate in the affairs of central banks.

3. DIFFERENCE BETWEEN COMMERCIAL
BANKS AND CENTRAL BANK
COMMERCIAL BANKS CENTRAL BANK
1.PROFIT MAKING IS FIRST CRITERIA. 1. CB THINKS ABOUT EFFECTS OF ITS
OPERATIONS ON WORKING OF ECONOMIC
SYSTEM.
CONSTITUTED FOR PROFIT MOTIVE. CONSTITUTED FOR PUBLIC SERVICES.
2.THESE MAY BE FEW OR MANY IN NUMBERS. 2.ONE IN EACH COUNTRY.
3. DEALS DIRECTLY WITH PUBLIC. 3.ACT AS BANKER’S BANK, DOES NOT DEAL
DIRECTLY WITH PUBLIC .

4. FUNCTIONS OF CENTRAL BANK
 According to De Kock functions of central bank are as :
 1.BANK OF ISSUE :-
 REGULATION OF CURRENCY IN ACCORDANCE WITH REQUIREMENTS OF BUSINESS
AND GENERAL PUBLIC.
 2.BANK AND AGENT:-
 PERFORMANCE OFGENERAL BANKING & AGENCY FOR THE STATE.
 3.CUSTODY OF CASH RESERVES OF COMMERCIAL BANKS.
 CENTRALISATION OF CASH RESERVES IN THE CENTRAL BANK IS THE SOURCE OF
GREAT STREANTH TO BANKING SYSTEM OF COUNTRY.
 4.CUSTODIAN OF FOREIGN BALANCES:
 CB CUSTODY THE NATION’S RESERVES OF INTERNATIONAL CURRENCY.
 5.LENDER TO LAST RESORT:
 GRANTING ACCOMODATION TO COMMERCIAL BANKS WHEN THERE IS CRISIS.
 6.CLEARING HOUSE:
 SETTLEMENT OF BALANCE BETWEEN BANKS.

5. CONTD…
 7.CONTROLLER OF CREDIT:
 CB ACT CONTROLLER OF CREDIT IN ACCORDANCE WITH NEEDS OF
BUSINESS AND WITH VIEW TO CARRYING OUT BROAD MONETORY POLICY
ADOPTED BY STATE.
 ADVANCES SHORT TERM LOANS TO GOVERNMENTS TO TIDE OVER
DIFFICULTIES.

6. METHODS OF CREDIT CONTROL
 1.QUANTITATIVE :-
 INTEND TO CONTROL OF VOLUME OF CREDIT BY COMMERCIAL BANKS.
 e.g., BANK RATE, OPEN MARKETING OPERATIONS.
 2.QUALITATIVE/SELECTIVE CONTROL:-
 INTEND TO CONTROL CERTAIN TYPE OF CREDIT.
 e.g., REGULATION OF CONSUMER CREDIT etc.

7. BANK RATE
 ALSO CALLED DISCOUNT RATE.
 IT IS THE RATE PRESCRIBED BY CENTRAL BANK.
 IT IS THE MINIMUM RATE AT WHICH CENTRAL BANK WILL DISCOUNT
FIRST CLASS BILLS OF EXCHANGE OR WILL ADVANCE LOANS AGAINST
APPROVED SECURITIES.
 THERE IS DIRECT RELATION BETWEEN BANK RATE AND MONEY MARKET
INTERST RATES.
 CHANGE IN BANK RATES ARE FOLLOWED BY CHANGE IN INTERST RATE
OF COMMERCIAL BANKS FOR SHORT TERM MONEY AND BANK LOANS
ADVANCES.
 IT IS IMPORTANT INSTRUMENT OF CREDIT CONTROL.

8. CONTD…
 RISE IN BANK RATE CAUSES ADVERSE EFFECT ON BALANCE OF TRADE
AND ADVERSE BOT CAUSE EXPORT OF GOLD.
 DUE TO INCREASE IN BANK RATE ALL OTHER MONEY RATES GOES UP.
 FOREIGNERS, WHO OBTAIN HIGHER RATE ON THEIR INVESTMENT WILL
NOT DRAW MONEY.
 THEIR WILL BE MOVEMENT OF CAPITAL INTO THE COUNTRY ON
ACCOUNT OF BETTER RETURN.
 THE DEMAND FOR DOMESTIC CURRENCY WILL RISE, RAISING ITS
VALUE.
 BORROWED FUNDS BECOMES COSTLY,LEADING TO DECLINE IN VOLUME
OF IMPORTS.
 THE BALANCE OF TRADE BECOMES FAVOURABLE AS A RESULT IN BANK
RATE.
 FOR SUCCESSFUL WORKING OF BANK RATE MECHANISM, MONEY
MARKET MUST BE INTEGRAL WHOLE i.e., CHANGE IN BANK RATE
SHOULD REFLEXIVE WITH MONEY MARKET RATE OF INTEREST.

9. CONTD…
 TWO DISTINCT VIEWS HAVE BEEN EXPRESSED BY HAWTREY AND KEYENES
REGARDING THE OPERATION OF RATE OF INTEREST AND INFLUENCE OF
INVESTMENT AND ECONOMIC ACTIVITY.
 HAWTREY VIEW: MOVEMENT OF SHORT TERM RATE OF INTEREST AFFECT
INCOME,OUTPUT AND EMPLOYMENT THROUGH THEIR INFLUENCE ON
STOCK HOLDER.
 `AS SHORT TERM RATE OF INTEREST GO UP, THEY WILL REDUCE STOCK
BECAUSE COST OF HOIDING HAS INCREASED.
 KEYNESIAN VIEW:KEYNES EXPRESSED OPINION THAT THESE ARE MAINLY
INFLUENCED BY CHANGES IN LONG TERM RATE OF INTEREST.
 INVESTMENT IN FIXED CAPITAL DEPENDS ON M.E.C. IN LONG RUN RATE
OF INTEREST.

10. OPEN MARKET OPERATIONS
 PROF. HALM REMARKS, “IN VIEW OF SHORT COMINGS REDISCOUNT
POLICY THE DEVELOPMENT OF OPEN MARKETINGOPERATIONS- THE
PURCHASE AND SALE OF GOVT. SECURITIES AND OTHER CREDIT
INSTRUMENTS IN OPEN MARKET – AS AN ADDITIONAL AND TO SOME
EXTENT ALTERNATIVE INSTRUMENT OF CENTRAL BANKING POLICY IS
LOGICAL STEP.”
 WHEN CENTRAL BANK WANTS TO REGULATE AMOUNT OF MONEY IN
CIRCULATION, IT RESORTS TO OMO, THE SALE AND PURCHASE OF
SECURITIES BY THE CB.

11. CONTD…
 IF THE CENTRAL BANK WISH TO DECREASE THE VOLUME OF CREDIT, IT
SELLS SECURITIES TO PUBLIC AND RECIEVES PAYMENT IN CASH OR
CHAQUES DRAWN ON COMMERCIAL BANKS.
 IF THE CENTRAL BANK WANT TO INCREASE THE CREDIT, IT BUYS
SECURITIES FROM MARKET EITHER BY PAYING CASH DIRECT TO PUBLIC
OR BY CHEQUE.
 OPEN MARKETING OPERATION IS IMPORTANT IN CREDIT CONTROL AND
PRODUCE THEIR EFFECT BY ALTERING CASH RESERVES OF COMMERCIAL
BANKS.
 THEY ARE EXTREMELY FLEXIBLE BOTH IN AMOUNT AND TIMING.
 AFFECT BANKING OPERATIONS WITH LEAST DISTURBANCE.

12. LIMITATIONS OF OPEN MARKETING OPERATION
 METHOD OF CREDIT CONTROL OR CREDIT EXPANSION MAY NOT ALWAYS HOLD
TRUE.
 FOR EXAMPLE, WHEN COMMERCIAL BANK FIND ADDITIONAL CASH THEY WILL
EXPAND CREDIT, WHENEVER THEY FIND THEIR CASH RESERVES
REDUCED,THEY WILL CONTRACT CREDIT.
 ACTUALLY THIS DOES NOT HAPPEN.
 CREDIT EXPANSION OR CREDIT CONTRATION IS MORE A MATTER OF BUSINESS
PSYCHOLOGY AND MOOD OF ENTREPRENERS.
 OMO CAN NOT BE USED IN DEVELOPING COUNTRIES AS NECESSARY
CONDITIONS FOR SUCCESS DOES NOT EXIST HERE.
 OMO BECOMES CHIEF INSTRUMENT OF CREDIT CONTROL IN COUNTRIES
WHERE MONEY MARKETS ARE WELL DEVELOPED.

13. BANK RATE VERSUS OPEN MARKET OPERATIONS
 THE USE OF BANK RATE & OMO CAN NOT BE SEPARATED FROM EACH OTHER,AS EACH BY
ITSELF MAY NOT BE AS EFFECTIVE AS DESIRABLE.
 FOR EXAMPLE, IF OPEN MARKET POLICY IS NOT FOLLOWED BY SUITABLE CHANGES IN
BANK RATE, IT MAY PROVE INEFFECTIVE.
 IF CB SELLS SECURITIES IN ORDER TO CONTROL CREDIT,BUT HAS NOT RAISED THE BANK
RATE , MEMBER BANKS WILL THEN REPLENISH THEIR RESERVES BY REDISCOUNTING THE
SECURITIES WITH CB BECAUSE THE BANK RATE IS LOW WHICH RENDER THE POLICY OF
CREDIT CONTROL UNSUCCESSFUL.
 WHEN THE BANK RATE WILL RAISED ,REDISCOUNTING WOULD NOT HAVE BEEN POSSIBLE
& CREDIT CONTROL WOULD HAVE BEEN MORE EFFECTIVE.
 ACC. TO PROF. HALM “ FROM THE STANDPOINT OF THEIR STRATEGIC VALUE TO CB, OPEN
MARKET OPERATIOS POSSESS A DEGREE OF SUPERIORITY OVER REDISCOUNT POLICY
BECAUSE OF THE FACT THAT INITIATIVE IN THE HANDS OF MONETORY AUTHORITY IN CASE
OF THE FORMER, WHILE BANK RATE POLICY IS PASSIVE IN THE SENSE THAT ITS
EFFECTIVENESS DEPENDS ON THE RESPONSES OF COMMERCIAL BANKS AND THEIR
CUSTOMERS TO CHANGE IN BANK RATES.

14. CONTD…
 OMO BECOMES SUPERIOR TO BANKRATE, BECAUSE THEY DIRECTLY
INCREASE OR DECREASE THE MONEY SUPPLY AND SHOW QUICKER AND
MORE DEFINITE RESULTS THAN BANK RATE CHANGES.
 OMO ARE ALSO LESS HARMFULL THAN BANK RATE CHANGES AS THEY
AVOID THE DIFFICULTIES OF INTERNATIONAL FLOWS OF CAPITAL WHICH
TAKES PLACE DUE TO CHANGE IN BANK RATE.

15. BANK RATE AND OMO IN DEVELOPING
ECONOMIES
 BANK RATE IN DEVELOPING ECONOMIES ASSUMES SIGNIFICANT ROLE
BECAUSE IT IS THE RATE AT WHICH PUBLIC CAN OBTAIN
ACCOMODATION FROM THE CENTRAL BANK,AT WHICH COMMERCIAL
BANKS OBTAIN ACCOMODATION FROM CENTRAL BANK.
 EFFICIENCY OF OMO IS HIGHLY DOUBTFUL IN SUCH ECONOMIES
BECAUSE BASIC CONDITION FOR SUCCESS LIKE BROAD AND
EFFECTIVE SECURITY MARKET ARE NOT FULFILLED.
 VOLUME OF SECURITIES IS VERY SMALL.

16. SELECTIVE CREDIT CONTROL
 THE EFFECTIVENESS IS ON CERTAIN SPECIFIC TYPE OF CREDIT WHILE OTHER TYPE OF
CREDIT REMAINS MORE OR LESS UNAFFECTED.
 IT SUITS TO DEVELOPING ECONOMY FOR THEY OFFER A WAY TO RESTRICT CREDIT
EXPANSION WHILE MAINTAINING LOW INTEREST.
 SELECTIVE CONTROL MEASURESARE:
 1.REGULATION OF CONSUMER CREDIT:-
 THIS MEASURE TO C0NTROL CREDIT WAS ADOPTED FIRST IN USA IN 1941 TO KEEP
CONSUMPTION SPENDING AT LOW LEVEL.
 IN THIS METHOD CB OF A COUNTRY IS AUTHORISED TO LAY DOWN TERMS AND
CONDITIONS FOR THE PROPER REGULATION OF CONSUMER CREDIT EXTENDED BY
COMMERCIAL BANK OF A COUNTRY.
 THROUGH THIS METHOD, PURCHASE OF CONSUMER DURABLES IS REGULATED.
 CONSUMER CREDIT REGULATION IS BASED ON THE OBSERVATION THAT MONETORY
DEMAND FOR CONSUMERS’ DURABLE GOOD IS EXTREMELY UNSTABLE AND IS OF
STRATEGIC IMPORTANCE TO GENERAL PRICE MOVEMENTS AND TO THE ECONOMIC
ACTIVITY IN THE ECONOMY.

17. 2. MARGIN REQUIREMENTS
 ‘MARGIN’ REFERS TO THE DIFFERENCE BETWEEN MARKET VALUE OF
SECURITIES AND THE AMOUNT BORROWED AGAINST THESE SECURITIES.
 FIRST TRIED IN USA IN 1934.
 THE IMPORTANCE OF THIS METHOD IS THAT A BANK WHILE ADVANCING
CREDIT AGAINST A SECURITY DOES NOT LEND FULL AMOUNT BUT LESS.
 IT IS DONE BY KEEPING A MARGIN BETWEEN VALUE OF SECURITY AND
AMOUNT OF ADVANCE TO COVER ANY POSSIBLE LOSS.
 DURING INFLATIONARY BOOM BUSINESSMAN AND SPECULATORS TRY TO
GET CREDIT BY PLEDGING GOLD OR SECURITIES TO THE BANK.

18. 3.MORAL PERSUATION
 THROUGH THIS METHOD, CB OFTEN EXERT GREAT INFLUENCE OVER
THE LOAN POLICY OF MEMBER BANKS.
 THERE IS CLOSE CO-OPERATION BETWEEN CB AND MEMBER BANKS.
 MORAL PERSUATION IMPELLES IMFORMAL REQUEST BY CB TO
COMMERCIAL BANKS TO CONTRACT LOANS IN TIME OF EXPANSION AND
TO EXPAND CREDIT IN TIME OF DEPRESSION.
 IT MAKE EASIER FOR CB TO SECURE THE WILLING AND ACTIVE CO
OPERATION OF MEMBER BANKS.

19. QUANTATIVE VERSUS QUALITATIVE
CREDIT CONTROL
 QUANTITATIVE CONTROL AIM AT REGULATION OF OVERALL VOLUME OF
BANK CREDIT.
 SELECTIVE CONTROL MAY HAVE DIRECT IMPACT ON PERTICULAR SECTOR
OF ECONOMY.THEIR EFFECTIVENESS IS LIMITED.
 WEAKNESS OF SELECTIVE CONTROLS IS THAT THEY DIRECTLY RESTRICT
INDIVISUAL CHOICE AMONG ALTERNATIVES.
 MERIT OF SELECTIVE CREDIT CONTROL IS THAT DURING
INFLATION,QUATITATIVE CONTROLS ARE LIKELY TO PULL THE ECONOMY
DOWN TO DEPRESSION,IF APPLIED TOO SEVERELY.
 FEAR OF SHORTAGE APPROACH LEAD MANY OBSERVERS TO PREFFER
SELECTIVE RESTRAINSTO CHECK INFLATIONARY LOANS.
 THE SELECTIVE CONTROLS ARE A GOOD SUPPLEMENT TO QUANTITATIVE
CONTROLS.

20. CENTRAL BANKING IN AN UNDER-
DEVELOPED ECONOMY
 IN UNDERDEVELOPED ECONOMIES CENTRAL BANKING INSTITUTIONS
ARE OF RECENT ORIGIN. “EVEN THOUGH RECENTLY ESTABLISHED,MOST
OF THEM ARE EQUIPED WITH LEGEL POWERS”.
 EFFECTIVENESS OF CENTRAL BANKING IS VERY MUCH REDUCED ON
ACCOUNT OF A LARGE NON-MONETISED SECTOR,UNORGANISED MONEY
MARKET, UNDERDEVELOPED STOCKS AND SHARES, BONDS AND
SECURITIES MARKETS.
 IN SUCH ECONOMY THE WEAPONS OF CREDIT CONTROL AND CREDIT
EXPANSION EITHER DO NOT WORK OR WORK WITH LOW EFFICIENCY.
 INTEREST RATES ARE INSTITUTIONALLY DETERMINED AND, THEREFORE ,
CAN NOT BE VARIED BY CHANGES IN BANK RATE.

21. CONTD…
 THE DEVELOPMENT OF COMMERCIAL BANK CAN BE ENCOURAGED
PARTLY BY PROVIDING CHEAP,LIBERAL AND LARGE SCALE RE-
DISCOUNTING FASCILITIES TO COMMERCIAL BANK AND PARTLY GIVING
SUBSIDY TO NEWLY STARTED BANKS.
 THESE ECONOMIES HAS TO MAINTAIN INTEREST RATES AT REASONABLY
LOW LEVELS.
 CB IN MOST OF UNDERDEVELOPED ECONOMIES HAVE HELPED
ESTABLISHMENT OF NEW COMMERCIAL BANKS ALONG WITH
DEVELOPMENT OF BRANCH BANKING.