What is Central Bank Explain its Functions

Central Bank & its Functions


Introduction & History of Central Bank


Money and credit play a very important role in modern society. We can derive maximum benefit from money and credit if their supply can be kept with in reasonable limits. Otherwise they will give rise to many social evils. Money supply takes place through commercial banks and other fin ncial institutions .They primarily to serve their own interest.


The central banking system was originated in different countries during the last century. But it was in a very crude form during that time. The modern system of central banking particularly developed in the 1st half of the present century (i.e. the 20th century). The need f the present century banking system was strongly felt during the financial crisis caused by First World War (1914-1918).


After the war there was complete confusion in currency and exchange markets. There were large with drawls of money from banks. The bank reserves fell below the needed level. There was no institution which could supervise the working of banks and also serve as a fiscal agent. In order to solve the monetary problems of the countries and set them on healthy footing, a conference was held at Brussels in 1920. It was decided in that conference that to control the supply of money and credit in the economy and maintain stable business conditions, each country must establish its own central bank.


Central bank is the most important bank of a country. Its important has increased manifold during past 50 years. It is the symbol of financial sovereignty and stability of the country. It is head of banking and monetary system. The principles on which a central bank operates are different from those of commercial bank. It does not work for profit. It acts in the public interest and earning profit is only a secondary consideration.


Evolution & Growth


The Riksbank of Sweden was set up in 1656 and dec ared as central bank in 1668 and is considered to be the old of the central banks. The Bank of Eng and was established in 1694. The Bank of France was set up in 1800. The national bank of Denmark w s opened in 1818 and National bank of Belgium in 1850. The Reich’s Bank of Germany was made in 1875. In U.S.A Federal Reserve System was set up in 1914. The Reserve Bank of India was formal in 1935 and the State Bank of Pakistan was established on July 1, 1948.


Organization of Central Bank


The organization of central bank differs from country to country. So it is difficult to speak of single types as a standard. There are central banks which are owned and managed by the private shareholders, such as the federal reserve system of the U.S.A. There are other central banks, The Bank of England, The Bank of France which are fully owned and managed by the government. Again there may be central banks which are jointly owned and managed by the government and Pvt Shareholders. UP to Dec 1973, the State bank of Pakistan was a government and private shareholders bank. Under The Bank Nationalization Ordinance 1974, The State Bank of Pakistan has become purely government owned institution. Today no central Bank is completely free the government influence.




Definition of Central Bank Simple defection


A Central bank is a bank, which controls credit.


Expert Views


According to Dr De. Kock:-


“The guiding principle of a central bank is that it should act only in the public interest for the welfare of the cou try as a whole and without regard to profits as a primary consideration”.


In words of Prof. Hawtry,s:-

“An institution which is


charged with the responsibility of managing the expansion and contraction of the volume of money in the interest of general public welfare”.


Objective of Central Bank


Following are the principles/objectives of central bank:-


1-Safeguarding Financial Stability:-



The main objective of the central bank is to protect and safeguard economical and financial stability. It is established in order to design and implement policies to avoid depression and unwanted fluctuations in economy.


2-Working In Public Interest:-


Central bank works in the best interest of the economy and public. It does not give advances, not it allows any interest on deposits. It performs its function without any consideration of profit.


3-Supervision Of Banking System:-


Central bank object is to have supervision and effective control over commercial banks structure, central bank set guidelines for commercial bank, and parameters in which commercial banks are allowed to perform their operation.



4-Control Of Credit & Money Supply:-


Central bank object is to exercise effective control over credit and currency supply in the economy. It has a sole monopoly over note issue and it constantly keeps an eye on the supply of currency in the economy. It also watches the credit creation of commercial bank.


5-Accommodation Commercial Banks:-


It saves commercial banks from bank runs and panics. It case commercial banks find any difficulty in meeting their liabilities; the central bank comes to their help.


6-Ensuring Economic Development:-


The objects of central bank are by direct finances towards important sectors of the economy and ensure that credit requirements of such sectors are full filed.



Function of central bank


A central bank usually performs the following function:-



Monopoly of Note Issue


In early periods of banking development, all banks used to issue their own notes. This caused confusion, frequent trouble, over issued, causing high inflation and economic crisis.

At present through out the world, central banks have the sole right of issuing currency notes. In Pakistan “State Bank of Pakistan” issues the currency notes of worth five to Rs 5000, (5, 10, 20, 50, 100, 500, and 1000). The main propose of giving the monopoly right of note issue area as under:-


Uniformity in the system of note issue.

The central bank can exercise better control over money supply.

It increases public confidence.



There are two principles of note issue:


Banking Principles

Currency Principles


Banker to the Government


Central bank is the banker to the Government. It means that central bank provides some important services for Government as:


1- Control of gold and other reserves of Government. Keeps the Government account.


2- Principle advisor of Govt (Regarding annual budget, taxation system, international trade and foreign exchange reserves etc).


3- To formulate of lending facility (For various projects).

4- Agent to Govt (Attending national and international conference on behalf of Govt).



Banker’s Banks


The control bank acts as banker to commercial bank as:


1- It holds cash reserves and deposits of commercial banks.

2- Discounting of bill of exchange of commercial banks.

3- Enabling the commercial banks to create credit. Clearing house facility (i.e. the settle ents of mutual claims of commercial banks).


4- Lender of last resort (Granting f loans to commercial banks in the days of finan ial crises).


5- Establishment of new banks (Prior permission necessary).


6- The advance policy (Keeping in mind the influence of rate of interest).


7- Every commercial bank sends a monthly statement of its assets and liabilities to central bank.



Lender of last Resort



Central bank is the lender of last resort to the commercial banks. It means that whenever the scheduled commercial banks are short of funds and are unable to get help from anywhere, it is the central bank which provides them loans and brings them out of trouble. A commercial bank gets loans from other banks in normal routine. But when they do not get such help, they approach the central bank.


Clearing House



Central bank also performs the functions of a clearing house. Since central bank holds the cash reserves of other bank, it easily helps to settle their mutual obligation. Payments by one bank to another are settled through central bank. Daily, in every bank, people deposit cheques which are to be drawn from other banks. In this way every bank has to receive amounts on behalf of its customers and has to make payments on behalf of them. But the banks do not get cash from each other. They settle their accounts with the help of central bank. Every bank has account at central bank, so funds can be transferred from the account of one bank to other bank.



Controller of credit



The central bank also regulates and controls the supply of money in the country. In order to anage the supply of money it implements monetary policy. The important tools of monetary policy are bank rate open market operation and varying reserve requirement.


Maintenance of exchange rate & foreign exchanges


The whole business of for ign exchange control and financing of international trade is done be the central bank. And give the suggestion to the govt. in case of balance of payment. As well as it control the forging exchange rate because a stable rate is promote the forging trade


Role in economic development


Through polices of central bank of any country is directly influence the rate of economic development. It establishes financial institutions with the help of it countries takes suitable measure to promote economic development.




The central bank can supervise activities of bank management. The bank has powers to look after working of commercial banks. If commercial banks are not follows the policy of central bank then the central bank imposed fine on banks.



Other functions


Representation in international financial institution (World Bank, IMF)

Industrial and agricultural bank Publication of annual report


Establishment of training institutes




Central bank play very important role in the economy, the policies of the central bank beneficial for the country as well as commercial banks, with the help of it rate of inflation becoming increase after it economic development started.


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