The central bank is regarded as the supreme monetary authority in every country, and accordingly it has to perform various useful functions for ensuring smooth functioning of the economy. Besides the discharge of certain traditional functions the central bank in a developing economy can play a special role, as is true of the Reserve Bank.
This role can be understood from the following functions performed by the RBI:
1. Expanding currency supply for financing development plans:
A developing country like India is to undertake massive development plans and programmes for accelerating the pace of development. The government requires a vast amount of finance for this purpose, for which the country is to rely on the method of deficit financing (i.e., the issue of new paper-notes) in addition to using other methods.
The banking sector is to provide adequate finance for this purpose. The central bank, being the sole note-issuing authority can assist the government by expanding the supply of currency to enable the government to finance its massive plan outlays.
Actually the Reserve Bank of India has been assisting the Government of India by expanding the supply of currency. But, the supply of currency (and credit) is to be properly regulated for enabling the economy achieve faster growth with reasonable price stability.
2. Resource mobilisation and supply of adequate credit:
The mobilisation of resources for development purposes is an essential requirement in a developing economy. In such an economy, the central bank can assist the government in mobilising domestic resources for financing the development plans through such activities as the floating of new loans of the government, strengthening the banking structure for mobilising resources even from the rural areas, and so on. Apart from these the central bank s to make necessary arrangements for the supply of adequate bank credit which is so essential for developmental activities.
3. Increasing the flow of bank credit to the priority sectors:
The formulation of development priorities is an essential characteristic of development planning. The central bank of a developing country is to frame its monetary and credit policy in such a fashion that larger and desired quantities of bank credit go to the priority sectors, such as agriculture, cooperatives, small industries and export trade.
Furthermore, for social and economic along with economic growth achieving, it has to formulate a policy for extending liberal bank credit to the weaker and hitherto neglected sections of the community.
At the same time it can follow the policy of credit restraint for maintaining price stability and for ensuring proper use of bank credit. For this reason the Reserve Bank of India has been following a monetary and credit policy what is known as the policy of controlled expansion of bank credit. Through it the R.B.I. can undertake the direct financing of development projects by lending liberally to those institutions which provide development finance.
4. Controlling inflation and containing cost escalation:
The rising price level is regarded as a concomitant of economic development. The central bank in a developing economy is required to take necessary steps in holding the price line at a desired level so that plan-estimates are not totally upset due to cost-escalation.
In a developing economy various traditional and new measures of monetary controls, especially selective credit controls, are used to check the inflationary rise in prices. The measures like higher margin requirements for speculative bank advances, higher CRR and incremental CRR, higher statutory liquidity ratios, penal rates of interest on excessive borrowings differential interest rate policy, higher bank rates and lending rates, etc. may be adopted by the central bank, as done by the Reserve Bank of India, for controlling inflation and for containing, or at least moderating, cost escalations of development projects.
5. Creation of a strong infrastructure and expansion of institutional facilities for agricultural and industrial finance:
For creating a strong and integrated infra-structure a developing economy is to extend institutional facilities for agriculture and industry, as such facilities are grossly inadequate. The central bank in such a country can take some positive steps for extending the institutional facilities for agricultural and industrial finance.
Thus, the Reserve Bank of India has taken active steps in reorganising the rural credit structure through co-operatives, the National Bank for Agriculture and Rural Development (NABARD), regional rural banks, lead banks.
Similarly, in developing institutional facilities for industrial finance it played a very significant role by establishing some specialised institutions like the Industrial Finance Corporation, the Industrial Development Bank, etc. The central bank in a developing economy usually sponsors the establishment of these institutions by subscribing to their shares and debentures by a large amount.
6. Operating exchange control:
Foreign exchange constraint is often found to be a serious obstacle to the growth of a developing economy. Accordingly, the central bank in such an economy can serve the best cause of growth by making proper arrangement for the judicious use of the country’s scarce foreign exchange, as had been done by the Reserve Bank of India at the early years of planning.
7. Development oriented monetary policy:
The central bank in a developing economy can formulate a development-oriented monetary and credit policy like the policy of controlled expansion of bank credit as followed by the Reserve Bank of India for promoting economic growth with stability. Through this monetary policy the central bank can bring about a desired allocation of resources especially capital.
This task is a very delicate one as it has to strike a balance between two apparently conflicting objectives:
(i) Expansion of the economy, and
(ii) Control of such expansion for achieving price stability.
8. Developing sound banking structure:
The central bank in a developing economy can also take various positive steps and adopt various measures such as deposit insurance, nationalisation of banks, creation of a suitable bill market scheme and so on for building a sound banking structure, or financial infrastructure which is essential for achieving faster economic growth.
9. Advising government on plan matters:
The central bank in a developing economy like India, can also advise the government not only on banking and financial matters but also on a wide range of economic issues related to national economic planning and resource mobilisation. Besides, a central bank should keep a strict watch over any possible sign of misdirection of the economy and accordingly it should give timely and proper advice to the government.
10. Economic surveys and collecting basic statistics:
Finally, the central bank in a developing economy like the R.B.I, often conduct surveys on various uncovered sectors and supply valuable data on national economic plans and policies to the government for formulating development plans.
Thus, the central bank has to play a special role in developing countries, viz., for promotion (expansion) of growth with stability. In most developing countries, at least at the early stage of development, there is unlikely to exist a sound commercial banking system which can make adequate provision for the growing need for finance. In such a situation, the central bank should come forward to fill in the credit gaps.