8 Major Functions of Central Bank – Discussed!

Eight major functions of central bank in an economy are as follows:

(1) Bank of Issue, (2) Banker, Agent and Advisor to Government, (3) Custodian of Cash Reserves, (4) Custodian of Foreign Balances,

(5) Lender of Last Resort, (6) Clearing House, (7) Controller of Credit, and (8) Protection of Depositor’s Interest.

Functions of Central Bank

Function 1 # Bank of Issue:

Central bank now-a-days has the monopoly of note-issue in every country. The currency notes printed and issued by the central bank are declared unlimited legal tender throughout the country.

Central bank has been given exclusive monopoly of note-issue in the interest of uniformity, better control, elasticity, supervision, and simplicity. It will also avoid the possibility of over-issue by individual banks.

The central banks, thus, regulate the currency of country and the total money-supply in the economy. The central bank has to keep gold, silver or other securities against the notes issued. The system of note-issue differs from country to country.

The main objects of the system of currency regulation in general are to see that:

(i) People’s confidence in the currency is maintained,

(ii) Its supply is adjusted to demand in the economy.

Thus, keeping in view the aims of uniformity, elasticity, safety and security, the system of note-issue has been varying from time to time.

Function 2 # Banker, Agent and Adviser to the Government:

Central bank, everywhere, performs the functions of banker, agent and adviser to the government.

“The central bank operates as the government’s banker, not only because it is more convenient and economical to the government, but also because of the intimate connection between public finance monetary affairs.”

As banker to the government, it makes and receives payments on behalf of the government. It advances short-term loans to the government to tide over difficulties.

It floats public loans and manages the public debts on behalf of the government. It keeps the banking accounts and balances of the government after making disbursements and remittances. As an adviser to the government it advises the government on all monetary and economic matters. The central bank also acts as an agent to the government where general exchange control is in force.

Function 3 # Custodian of Cash Reserves:

All commercial banks in a country keep a part of their cash balances as deposits with the central bank, may be on account of convention or legal compulsion. They draw during busy seasons and pay back during slack seasons. Part of these balances is used for clearing purposes. Other member banks look to it for guidance, help and direction in time of need.

It affects centralisation of cash reserves of the member banks. “The centralisation of cash reserves in the central bank is a source of great strength to the banking system of any country. Centralised cash reserves can at least serve as the basis of a large and more elastic credit structure than if the same amount were scattered amongst the individual banks.

It is obvious, when bank reserves are pooled in one institution which is, moreover, charged with the responsibility of safeguarding the national economic interest, such reserves can be employed to the fullest extent possible and in the most effective manner during periods of seasonal strain and in financial crises or general emergencies…the centralisation of cash reserves is conducive to economy in their use and to increased elasticity and liquidity of the banking system and of the credit structure as a whole.”

Function 4 # Custodian of Foreign Balances:

Under the gold standard or when the country is on the gold standard, the management of that standard, with a view to securing stability of exchange rate, is left to the central bank.

After World War I, central banks have been keeping gold and foreign currencies as reserve note-issue and also to meet adverse balance of payment, if any, with other countries. It is the function of the central bank to maintain the exchange rate fixed by the government and manage exchange control and other restrictions imposed by the state. Thus, it becomes a custodian of nation’s reserves of international currency or foreign balances.

Function 5 # Lender of Last Resort:

Central bank is the lender of last resort, for it can give cash to the member banks to strengthen their cash reserves position by rediscounting first class bills in case there is a crisis or panic which develops into ‘run’ on banks or when there is a seasonal strain. Member banks can also take advances on approved short-term securities from the central bank to add to their cash resources at the shortest time.

This facility of turning their assets into cash at short notice is of great use to them and promotes in the banking and credit system economy, elasticity and liquidity.

Thus, the central bank by acting as the lender of the last resort assumes the responsibility of meeting all reasonable demands for accommodation by commercial banks in times of difficulties and strains.

De Kock expresses the opinion that the lending of last resort function of the central bank imparts greater liquidity and elasticity to the entire credit structure of the country. According to Hawtrey, the essential duty of the central bank as the lender of last resort is to make good a shortage of cash among the competitive banks.

Function 6 # Clearing House:

Central bank also acts as a clearing house for the settlement of accounts of commercial banks. A clearing house is an organisation where mutual claims of banks on one another are offset, and a settlement is made by the payment of the difference. Central bank being a bankers’ bank keeps the cash balances of commercial banks and as such it becomes easier for the member banks to adjust or settle their claims against one another through the central bank.

Suppose there are two banks, they draw cheques on each other. Suppose bank A has due to it Rs. 3,000 from bank B and has to pay Rs. 4,000 to B. At the clearing house, mutual claims are offset and bank A pays the balance of Rs. 1,000 to B and the account is settled. Clearing house function of the central bank leads to a good deal of economy in the use of cash and much of labour and inconvenience are avoided.

Function 7 # Controller of Credit:

The control or adjustment of credit of commercial banks by the central bank is accepted as its most important function. Commercial banks create lot of credit which sometimes results in inflation.

The expansion or contraction of currency and credit may be said to be the most important causes of business fluctuations. The need for credit control is obvious. It mainly arises from the fact that money and credit play an important role in determining the level of incomes, output and employment.

According to Dr. De Kock, “the control and adjustment of credit is accepted by most economists and bankers as the main function of a central bank. It is the function which embraces the most important questions of central banking policy and the one through which practically all other functions are united and made to serve a common purpose.”

Thus, the control which the central bank exercises over commercial banks as regards their deposits, is called controller of credit.

Function 8 # Protection of Depositors Interests:

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

The business of banking has, therefore, been recognized as a public service necessitating legislative safeguards to prevent bank failures.

Legislation is enacted to enable the central bank to inspect commercial banks in order to maintain a sound banking system, comprising strong individual units with adequate financial resources operating under proper management in conformity with the banking laws and regulations and public and national interests.