Central bank

1. Chapter 7
Central Bank
Money & Banking
Part II: Banking

2. Contents of the Chapter
I. The central bank
II. Function of Central Bank
III. Monopoly of Notes Issue and Methods
IV. Monetary Policy

3. I. Central Bank
 The central bank is the head, the leader, and
the supervisor of the banking and monetary
system of a country. Almost every country of
the world has its own central bank.
 A central bank is an institution which is
responsible for safeguarding the financial
stability of the country.

4. I. Central Bank
 Central Bank does not work for profits though it
might secure profits. While Commercial Banks aim
at securing maximum profit for their shareholders,
the Central Bank aims at controlling the banking
system and supporting the economic policy of the
government.
 Central Bank is generally an organ of the
government and forms part of the govt. machinery.
Commercial Banks may be owned by the govt. or
are privately owned.
 The Organization and Management of the Central
Bank is fully controlled by the Government.

5.  It is the most powerful economic institutions that
has been developed to help society to manage its
collective financial affairs.
 The activities of the central bank regarded
essential for the proper functioning of the
economy.
 Almost all the central banks were started as
private owned banks and concerned about profits
and so, they competed with commercial banks.
 The central banks have crystallized (shaped) into a
distinct entity of their own.
Nature of Central Bank

6. II. Functions of a Central Bank
1. Sole Right of Note Issue and regulation
2. Bankers, Agent and Adviser to the Government.
3. Banker to Commercial Banks
4. Controller of Credit
5. Clearing Agent
6. Lender of the Last resort
7. Development role
8. 8. Custodian of Foreign Exchange Reserves.
9. Research and Data Collection
10. Other Functions

7. 1. Sole Right of Note Issue and regulation
 Central Bank has the Monopoly of note issue. It is one
of the most important functions of a central bank. The
reasons for delegation of authority to note issue are as
follow.
 It brings uniformity in the system of note issue which will
facilitate trade and exchange within the country
 The central bank can exercise better control over the
money supply in the country.
 Increase public confidence in the monetary system of the
country.
 Enables central bank to control the lending operations of
the commercial banks.

8. 1. Sole Right of Note Issue and regulation
 To imprint the notes with a distinct prestige.
 To restrict or expand the supply of notes according to the
requirements of the economy.
 To bring stability in the monetary standard and create
confidence among the pubic.

9. 2. Bankers, Agent and Adviser to the Govt.
The Central Bank acts as banker agent and adviser to
the Government.
1. As Banker to the Government, it receives
deposits, Cheques and drafts deposited in the
government account.
2. It makes short term advances to the
Government.
3. It provides foreign exchange to government for
the purchase of foreign goods, repaying external
debts.
4. As Financial Agent, it collects taxes and other
payment on behalf of the Government.
5. As an agent, the central bank makes short term
loans to the government.

10. 3. Banker to Commercial Banks
1. It holds cash reserves and deposits of
commercial banks.
2. It rediscounts the bills of exchange of
commercial banks to cover temporary
difficulties.
3. Influence the creation of credit by the
commercial banks in the best interest of the
country.

11. 4. Controller of Credit
Central bank tries to establish,
i. Stability in the internal price level of the
country.
ii. Stability in the exchange rates
iii. Instrument of credit control are (i) Bank Rate
(ii) Open Market operation (iii) Cash Reserve
Ratio.

12. 4. Controller of Credit
Methods of Credit Control:-
 Money and credit represent a powerful force for
good or evil in the economy.
 Money cannot manage itself. It is the duty of the
central bank to ensure that money and credit is
properly managed so that inflationary and
deflationary pressures can be controlled in the
economy.
 In modern times, bank credit has become the
important source of money and commercial banks
have unlimited power to expand or contract credit.
 A central bank has to control credit created by
commercial banks.

13. 5. Clearing Agent
 As commercial banks keep their cash
reserves with the Central bank.
 Central Bank can easily settle the claims of
various banks against each other with least
use of cash.

14. 6. Lender of the Last resort
 As central bank is Supreme bank of the country,
so if commercial banks fail to meet their
financial requirements so commercial bank can
approach to the central bank for financial
accommodation.
 The central bank as lender of last resort provides
financial help to the commercial banks.

15. 7. Development Role
 Central bank undertakes the responsibility of
economic growth with stability in the economy.
 It ensures that the funds available flow to the
various priority sectors such as agricultures,
export sector small scale sector.

16.  The central bank keeps and manages the foreign
exchange reserves of the country.
 Funds coming from and going out to foreign countries
are channeled through the central bank.
 All the incomes in foreign currencies accured to the
central bank to go the foreign exchange accounts and
payments are met from these accounts.
 All the balances are kept under the custody of bank.
 Further, the central banks in most countries maintain
both gold and foreign currencies as reserves against
note issue and also meet adverse balance of
payments.
8. Custodian of Foreign Exchange Reserves.

17.  In addition to above functions, a modern
central bank collects and publishes important
monetary data pertaining to the working of
the banking system and the economy as a
whole.
 It helps to understand the nature and
magnitude of problems facing the economy
and seeks the solutions thereof.
9. Research and Data Collection

18. 10. Other Function
1. It maintains relation with international
agencies such as IMF, world bank.
2. It provides training facilities to the staff
working in various banking institutions.
3. It conducts seminars, surveys and publishes
and annual reports giving real economic
picture of the economy.
“Annual bulletin report” issued from Da
Afghanistan Bank, which show information
related to economy.

19. III. Central Bank’s Monopoly of
Note Issue & Method

20. Monopoly of Note issue
 Central bank is the only authority to issue Notes
in a country as we discussed early as well that
issuing of notes by the central bank only have
some advantages like;
1. Uniformity in note circulation.
2. Control over money supply
3. Control over commercial banks
4. Public confidence.

21. Principle of Notes Issue
 Currency Principle
 Central bank of the country should keep 100%
Gold for every note issued. It means full
convertibility of notes.
 Banking Principle
 No need to keep 100% gold or silver against
notes issued. The note issued in the country
should be according to the needs of trade and
industry.

22. Cont….
 Fixed Fiduciary System
 This is widely recognized as an important
method of note issue.
 Under this system a limit of volume of
currency has been fixed by central authority.
 This limit is called fiduciary limit.
 Any note issue in this fiduciary limit is to be
backed by government securities.

23. IV. Monetary Policy

24. Monetary Policy
 Monetary Policy is the deliberate exercise of the
monetary authority’s power to induce expansion
or contraction in the money supply.
 Objectives
 Promoting high employment.
 Achieving steady economic growth.
 Stable price level as a goal.
 Stability in Interest rate.

26. Tools of Monetary Policy
A. Quantitative Control
i) Open Market
ii) Bank Rate
iii) Credit Rationing
iv) Varying Reserve
B. Qualitative Controls
i) Consumer’s credit
ii) Use of moral
persuasion
iii) Direct Action
Tools

27. A. Quantitative Instrument

28. A.i. Open Market Operation
It refers to purchase and sale of govt. securities by
the central bank in open market,
During inflation…
Central bank sells securities which results
decrease in supply of money…
During deflation…
Central bank purchase securities which results
increase in supply of money

29. A.ii. Bank Rate Policy
Bank rate is the rate of interest at which central
bank advances loans to the commercial banks.
 When central bank increase the bank rate,
commercial banks raise interest rate in giving out
loans ,for decreasing the flow of money.
 When central bank decrease the bank rate,
commercial banks lower the interest rate in giving
out loans, for increasing the flow of money.

30. A.iii. Credit Rationing
Under this method Central bank allots credit
quota (portion) to commercial banks on basis of
their business…
In case of inflation…
Central bank decrease credit quota…
In case of deflation…
Central bank increase credit quota….

31. A.iv. Varying Reserve Ratios
Central bank also control the credit by changing
the reserve ratios of commercial banks which is
normally 25%....
In times of inflation:
Central bank increase the reserve ratio
In times of deflation:
Central bank decrease the reserve ratio

32. B. Qualitative Controls

33. B.i. Consumer Credit Control
 The consumer credit control technique of
monetary management can be applied when
there arises a scarcity of certain listed articles in
the country.
 The central bank will invoke specific restrains on
consumer credit by raising the required down
payment and shortening the maximum period of
repayment.

34. B.ii. Use of Moral Persuasion
 If the commercial banks are pursuing the policy
which the central bank does not like, it can call
the meeting of the commercial banks and can
explain to them the difficulties which the central
bank of the country is facing.
 Central bank can also give them threats that if
they do not follow the policy, so Central bank
would not supply credit in times of crisis to them.
Its only for short period of time.

35. B.iii. Direct Action
 If commercial banks are following the policy
that is inconsistent with the monitory policy of
central bank…
 It can take direct action by imposing penalty
over commercial banks…Like banning its new
branches.

36. Conclusion
 In every country, there is one bank which acts
as the leader of the money market,
supervising, controlling and regulating the
activities of Commercial Banks and other
financial institutions.
Thank you