Central Bank: Meanings, Features, Workings With Commercial Banks, Detailed Review

The Central Bank

The central bank is an apex bank that controls entire banking system of a country. Central bank is the sole agency of note issuing in the country and controls the supply of money in the economy.

Central bank of the country serves as a banker to the government and manages forex (foreign exchange) reserves of the country. Reserve Bank of India is the central bank of India which is established in 1935 under the Reserve Bank of India Act, 1934.

Functions of the Central Bank

Principal functions of the central bank as under:

• Bank of issuing Notes: Central bank of a country has the exclusive right or monopoly right of issuing notes in the economy. This function of issuing notes is known as Currency Authority function of the central bank. The notes issued by the central bank in the economy are an unlimited legal tender (coins are not included).
• Banker to the Government: Central bank is a banker to the government, and also agent, and financial advisor to the government.

1. As a banker to the government, it manages accounts of total income and expenditure in the economy.
2. As an agent to the government, it buys and sells securities on behalf of the government.
3. As an advisor to the government, it frames policies to regulate the money market.

• Banker's Bank and Supervisory Role: As a Banker's Bank, it has almost the same relation with other banks in the country as a commercial bank has with its customer. Three following observations need to be noted in this context:

1. The central bank accepts deposits from the commercial banks, and offers them loan.
2. The central bank provides 'Clearing House' facility to the commercial banks. Clearing housing facility refers to the cheque clearing facility provided at one centre i.e. central bank to all the commercial banks.
3. In its supervisory role, the central bank ensures that the commercial banks show compliance to its directives, particularly relating to CRR and SLR. The central bank changes CRR, SLR as when required. It ensures that the commercial banks show compliance to these changes with the central bank so that the desired targets of the commercial banks are achieved.

• Lender of Last Resort: It means that if a commercial bank fails to get financial accomodation from anywhere, it approaches the central bank as a last resort. Central bank advances loan to such commercial banks against approved securities. By offering loans to the commercial banks in situations of emergency, the cenrtal bank ensures:

1. That the banking system of the country does not suffer any set-back, and
2. That money market remains stable.

• Custodian of Foreign Exchange: Central bank is also works as a custodian of nation's foreign exchange reserves. It also excercises 'managed floating' to ensure stability of exchange rate in the international money market. Managed floating refers to the sale and purchase of foreign exchange with a view to achieving stability of exchange rate for the domestic currency.
• Clearing House Function: Central bank performs the function of a clearing house. Let us take an suitable example to understand this function more clearly. Supposing, Bank A receives a cheque of ₹10,000 drawn on Bank  B, and Bank B receives a cheque of ₹15,000 drawn on Bank A. Both, Banks A and B have their accounts with the central bank. The cheques of both the banks (Bank A and Bank B) are cleared through their accounts with the central bank. This is how the central bank acts as a clearing house. It avoids transfer of cash between the banks and reduces requirement of cash. 
• Control of Credit: The principal function of the central bank is to control the supply of credit in the economy. It implies increase or decrease in the supply of money in the economy by regulating the 'creation odfcredit' by the commercial banks. The central bank needs to control the supply of money in the economy to cope with the situations of inflation and deflation. During inflation, the supply of money is reduced and during deflation, it is increased. 

Performing of these functions, the central bank forces on growth and development with stability. (Growth refers to the sustained rise in GDP. Stability refers to the elimination of inflationary and deflationary situations within the economy.