Central Banking Essay Sample

Central Banking is one of the most useful institutions which human ingenuity has developed to help the society in managing its collective financial affairs. Every country, these days has a Central Bank which controls its entire banking system. Few countries had a Central Bank in the 19th century, but the popularity of the Central Bank has greatly increased in the 20th century. Today, there is hardly any country in the world which does not have a Central Bank of its own.

After the First World War, an International Monetary Conference was held at Brussels in 1929 to find a solution to the problem of recurring economic crisis which confronted the world. This conference recommended the solution to setting up a Central Bank in every country. The Central Bank occupies a pivotal position in the Monetary and Banking structure of the country. The Central Bank is the undisputed leader of the money market. It supervises controls and regulates the activities of the commercial banks affiliated with it.

The Central Bank is also the highest monetary institution in the country charged with the duty and responsibility of carrying out the monetary policy formulated by the government. India’s Central Bank known as the RESERVE BANK OF INDIA was setup in 1935. The bank of England is the oldest Central Bank in the world. It assumes Central Banking functions in the second half of the 19th century. In America, the Central Bank known as the Federal Reserve System which was established in the year 1930.

DEFINITIONS OF CENTRAL BANKING Many economists have given different definitions of Central Bank based on functions performed by the central bank. Some of them with economists are as follows:- “A Central Bank is a bank of bankers. Its duty is to control the monetary base…. and through control of this ‘high-powered money’ to control the community’s supply of money. ” — SAMUELSON “The essential function of a Central Bank is the maintenance of the stability of the monetary standards. ” — KISCH AND ELKIN.

“The business of a Central Bank as distinguished from a commercial bank is to control the commercial banks in such a way as to promote the general monetary policy of the state. ” Thus, according to him, the major function of the Central Bank is to carry out the monetary policy formulated by the government of the country. — R. S. SAYERS “The one true, but at the same time, all sufficing functions of a Central Bank is to control of credit. ” He gives exclusive importance to control of credit as the major functions of central bank. — W. A. SHAW.

“The primary function of Central Bank is a banking system in which a single bank has either a complete or a residuary monopoly in the note issue. It was out of monopoly in the note issue that were derived the secondary functions and characteristics of our modern Central Banking. ” — VERA SMITH From the above definitions, it is concluded that: “The Central Bank may be defined as the apex banking and monetary institutions whose main function is to control, regulate and stabilize the banking and monetary system of the country in the national interest. ”

NECESSITY OF CENTRAL BANKING The need for a Central Banking Institution in a country arises from the following: – 1. CONTROL OF CREDIT: – every commercial bank creates credit during its daily operations. In fact, credit creation is supposed to be the major function of the commercial banks. But this credit creation sometimes poses serious dangers for the economy of the country. 2. ISSUE OF PAPER CURRENCY: – a Central Bank is also required to issue paper currency. The reason is that the note issue by the central bank satisfies the requirement of elasticity.

Moreover, the note issue of Central Bank is based strictly on economic considerations. As against this, the system of note issue of the government lacks elasticity. It may be also be influenced by political considerations. 3. ECONOMIC HELP TO THE COMMERCIAL BANKS: – a Central Bank is also required to help commercial banks to tide over economic crisis. In the absence of the Central Bank, the commercial banks are likely to fail at the slightest crisis in the economy. 4.

IMPLEMENTATION OF THE GOVERNMENT’S MONETARY POLICIES: – since the Central Bank exercises full control over the banking system of the country, it is in a position to implement successfully the monetary and financial policies of the government. PRINCIPLES OF CENTRAL BANKING Following are the main principles of Central Banking:- 1. THE CENTRAL BANK IS ALWAYS INSPIRED BY THE SPIRIT OF NATIONAL WELFARE: – the commercial banks are generally guided almost exclusively by the profit motive. Central Bank is always inspired by the spirit of national welfare.

The directive principle of the central bank is that it should work exclusively in the interest of public welfare. It should not considered profit as primary motive. It implies that the profit motive for the Central Bank should only be a secondary consideration. 2. MONETARY AND FINANCIAL STABILITY: – another important principle of a Central Banking is that the central bank should help in the maintenance of monetary and financial stability in the country. There are several weapons in the armory of the Central Bank which it can utilize for the achievement of this objective.

3. FREEDOM FROM POLITICAL INFLUENCE: – Central Bank should remain free from all political influences. It should not allow itself to be dominated by the ideology of a particular party. On the contrary, it should work strictly in accordance with well known principles of Central Banking. It is also necessary that there should be perfect cooperation between Central Bank and the government of country. The reason is that the economic problem of the country can not be satisfactorily solved with out the fullest cooperation between the government and the Central Bank. 4.

NO COMPETITION WITH MEMBER BANKS: – the Central Bank is a parent bank just as parents don not compete with children, the Central Bank should, under no circumstances, compete with the member banks in receiving deposits from the public or extending loans to the needy borrowers. If it competes with the members this will conflict with its important functions of being a banker’s bank, controller of credit and lender of the last resort. FUNCTIONS OF CENTRAL BANK The functions of Central Bank differ from country to country in accordance with the prevailing economic situation.

The main functions of Central Bank of almost all countries are as follows: – 1. THE CENTRAL BANK ENJOYS MONOPOLY OF NOTE ISSUE: -in the 19th century, the Central Bank had the right of note issue by this the advantages have accrued from the system of note issue by the central bank is: Uniformity in the monetary system which means to exercise proper control over the supply of money in the country. Greater public confidence. This method strengthens public confidence because Central Bank enjoys a high status in the public. Elasticity in the monetary system, as the Central Bank is the top most bank, it manages the paper currency system.

It can vary the quantity in accordance with the varying requirements of the economy. Control on credit creations. It helps the Central Banks to exercise control on the creation of the credit by the commercial banks because it depends upon the volume of paper currency issued by the Central Bank. Profit for the government. The Central Bank earns the profit out of the issue of paper currency which all profit goes to the government. Stability in the internal and external value of money. As monopoly of note issue, the Central Bank maintains the stability in internal and external value of home currency.

There do not occur white fluctuations in exchange rate. 2. THE CENTRAL BANK ACTS AS THE BANKER, AGENT AND ADVISOR TO THE GOVERNMENT: – as the government bankers, Central Bank keeps the accounts of various government departments and institutions. It accepts deposits from the government which includes collection of checks and drafts, transfer government funds from one place to another and from one account to another. It provides short term loans to government. It also provides foreign exchange resources to meet external dept or for purchases of foreign goods.

It keeps liquidity conditions in the market. New loans and treasury bills are issued by Central Bank on behalf of government. It also receives tax and other payments as government’s fiscal agent. Central Bank possess full information about the working of the economic this shows it is a financial advisor to the government. 3. THE CENTRAL BANK ACTS AS A BANKER’S BANK: – broadly speaking the Central Bank acts as the banker’s bank in three different capacities: The Central Bank is the custodian of the case reserve of commercial banks.

Every commercial bank has to keep a certain percentage of its liabilities with the Central Bank in the form of case reserves. The centralization of case reserves with the Central Banks reinforces the confidence of the public in the strength of the banking system of the country. So that, they can be used in a more effective manner during periods of seasonal and financial stringency. This system of centralized case reserves which enables the central banks to functions as lender of last resort. It ensures elasticity in the credit structure of the country.

It can make use of case reserves in the interest of national welfare. The Central Bank is the lender of last resort. The commercial banks can carry on their activities on the basis of smaller case reserves. They can secure financial help from the Central Bank at a time of crisis. This system helps the commercial bank to maintain the liquidity of their financial resources. This function of the Central Bank offers an opportunity for the central bank to establish its control over the banking system of the country.

The Central Bank is the bank of central clearance, settlements and transfers. The main operation of Central Banking is clearing house for the commercial banks, it holds the case reserves of the commercial banks, and it becomes easier and more convenient for it to acts as the clearing house of the country. All the commercial banks have their accounts with the Central Bank. The Central Bank can settle the claims and counter claim of the commercial banks with the minimum use of case. Thus, the clearing house function of the Central Bank economizes the use of case by the banks.

4. THE CENTRAL BANK IS THE CUSTODIAN OF THE NATIONS GOLD AND FOREIGN EXCHANGE RESERVES: – it is an important function of Central Bank. If there are fluctuations in foreign exchange rates, the Central Bank in order to minimize them, may have to buy and sell foreign currency in the market. It is the responsibility of the central bank to maintain stability in the rates of foreign exchange. In case of emergency, the Central Bank may even imposed control on buying and selling of foreign currencies in the market. 5.

THE CENTRAL BANK PUBLISHES ECONOMIC STATISTICS AND OTHER USEFUL INFORMATION: – in every country, the Central Bank collects and publishes statistics about the various aspects of the functioning of the national economy. This provides valuable information on the basis of which the government can formulate and implement its economic policies. 6. THE CENTRAL BANK ACTS AS THE CONTROLLER OF CREDIT: – the most important function performed by the Central Bank. If the Central Bank is able to keep the creation of credit with limits, it can prove a blessing for the country.

But if credit is not effectively controlled and kept with in limits, it can have dangerous consequences for the economy. It is essential that the creation of the credit is kept with in reasonable limits by the Central Bank. And there is no other institution which can control credit more effectively than the Central Bank. By controlling credit in an effective manner, the central bank can help to bring about not only stability in the internal price level but can also check fluctuations in the foreign exchange rates. CONCLUSION The Central Bank is not merely a regulatory authority but it is also an agency of economic growth.

The Central Bank takes all possible steps from time to time to stimulates the economic growth of the country. The Central Bank is also taking steps to spread banking facilities in the hitherto inaccessible areas in these countries. It also strengthens the organization of money and capital markets in these countries with the view to helping the process of investment for development purposes. By providing cheap credit, the Central bank also tender useful advice to their government on economic and financial matters with the ultimate objective of speeding up the process of economic growth.