The Roles of Central Bank for an Economy

The central banks are state-owned financial institutions that perform the authority of controlling the money market and perform the especially responsibility of production and distribution of money and credit for a nation on behalf of its government. Central banks are called in many different names, such as mother bank, reserve bank, monetary authority, etc.

Importance of Central Banks

Central banks play a vital role in economic and financial stability. By conducting monetary policies, central banks try to control inflation levels by setting guidelines for commercial banks. It enables them to carry on banking activities with their limited cash. Central banks also increase the elasticity and liquidity of the whole capital structure of the economy by working as the lender of the last resort. Interest rate intervention of central banks also plays an important role in economic and financial stability by influencing the stock and bond market to some extent.

Above all, the importance of central banks reflects in their primary function. The core responsibility of a central bank is to issue currency. Although currency may look like assets, issuing currency is the most significant liability of the central banks. Central banks back issued currencies with other forms of assets, especially with gold. A stable economy requires a strong currency and a strong currency requires a balance between issuance and production of total goods in a country within a year. (www.imf.org/en/About/Factsheets/)

The 7 Important Roles of Central Banks

The Issuer of Bank Notes

The central bank has the monopolistic authority of note issues in almost every country worldwide. Currency notes issued by central banks are the only legal tender in almost every country, and the central bank backs an equivalent amount of assets whenever they issue new notes. However, it is common that the central bank is not the only issuer of currency in some countries. In some countries ministry of finance issues government notes, and the central bank issues banknotes, whereas the central bank uses government notes as assets to back the issuance of banknotes.

Bankers’ Bank

The central bank work as a banker for other banks in a country in three different ways

As a keeper of cash reserves of the commercial banks: Commercial banks have to deposit a certain percentage of their total cash as a reserve amount in central banks. This cash amount is reserved for the emergencies of commercial banks.

As the lender of the last resort: The central bank is considered the last hope for commercial banks when they face the emergency need for loans, and when there is no other option for them, they can take loans from the central bank for daily business purposes.

As a clearing agent: Commercial banks make transactions among them every day, and clearing and reconciling those transactions requires central banks as the agent.

Banker, Agent, and Advisor of the Government

• As an agent of government central bank collect government taxes and payment on behalf of the government and pay to others on behalf of the government. Whenever government requires money central bank issues Treasury bonds to collect the necessary amount of money as public debt.
• As an adviser of finance, central banks help the government decide monetary policy, economic matters, and financial matters such as trade policies, foreign exchange policy, deficit financing, etc.
• As a government banker, the central bank performs general banking activities that commercial banks perform for account holders.

Regulator of the Banking Industry

The central bank is the highest authority that controls and regulates other commercial banks. The central banks set CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) for commercial banks to keep commercial banks out of liquidity shortage threats. The central banks also make sure that all the enlisted banks follow banking laws set by the government.

Implementing Monetary Policies

Central banks make sure that everyone within the country follows the chosen monetary policies at the basic level of the financial system. As central banks issue currencies on behalf of the government, they need to back their currencies with any asset for the public to believe in their currencies. And based on this concept of ensuring safety, there are different monetary policies for issuing banknotes. These are

• Fiat currency
• Gold-backed currency

Besides, other important matters are also taken care of by the central bank, such as will there be any Currency board and Currency union or not. In the case of the USA, their central bank (Federal Reserve System) regulates monetary policies. (www.cnbc.com/2021/12/03/imf)

Determining Interest Rates

One of the main factors that influence determining the interest rate of any commercial bank is the rate of interest that the central banks set for commercial banks to take loans.

This rate is known as the Bank rate. Suppose the central bank sets a high bank rate. In that case, it will force commercial banks to increase the interest rate on lending activities. If the bank rate is low, commercial banks will have a low cost of capital; It will allow the commercial banks to charge a lower interest rate on loan disbursement.

Setting the Official Interest Rate

It is used to manage the foreign exchange rate of a currency and also used to stabilize the required inflation rate.

Objectives of Central Banks

Through their roles and functions, central banks try to achieve some objectives, and these are

• Price stability
• Economic growth
• Inflation rate-controlling
• Foreign exchange stability
• Financial market stability etc.
• Credit control of financial markets
• Implementing government policies
• Cooperating with international financial institutions
• Increase in jobs/ employment
• Controlling public finance

Bottom Line

The bottom is the net income in the case of the companies; the line at the end of an income statement that is seen below net profit is called the bottom line. It is the income of a company after all expenses. It usually represents the final goal or achievement of anything. In the case of profit-oriented companies, it is net profit in the income statement, but it can be the ultimate objective/goal/achievement in other organizations.

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Bibliography

• .theguardian.com/business. (n.d.). Retrieved from https://www.theguardian.com/business/2015/feb/16/the-central-banks-and-their-bottom-line
• www.cnbc.com/2021/12/03/imf. (n.d.). Retrieved from https://www.cnbc.com/2021/12/03/imf-urges-fed-to-speed-up-policy-tightening-amid-rising-inflation-risk.html
• www.imf.org/en/About/Factsheets/. (n.d.). Retrieved from https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/20/Monetary-Policy-and-Central-Banking#:~:text=Central%20banks%20play%20a%20crucial,to%20manage%20volatile%20exchange%20rates.