The following points will highlight the fourteen important functions of the central bank in economy of a country.
Function # 1. Monopoly of Note-Issue:
The central bank controls the issue of notes. It has the sole right (monopoly) in note issue. It prints notes and authorises the minting of coins by the Mint.
Old notes and coins are removed by the commercial banks as they deteriorate. The central bank thus provides us with the much-needed medium of exchange. In other words, central bank notes and coins are legal tender.
In most countries note issue by the central bank is based on a particular principle. In order to prevent an over-issue of notes, apart from a fiduciary issue (that is, notes backed by securities), all notes are to be backed by an equivalent amount of gold in the bank. However, over the years, the fiduciary issue has risen steadily and, today; the whole of the note issue is fiduciary.
To regulate the supply of currency the central bank in every country has been given the monopoly right to issue paper-notes in accordance with the existing legal provisions.
Function # 2. The Banker to the Government:
The central bank acts as the banker to the government of the country. It keeps the cash balances of the government and maintains its accounts. It gives advances to the government and also takes the responsibility of the sale of government securities. It manages public debt and gives advice to the government on various financial matters.
Function # 3. The Banker to Other Banks:
The central bank acts as a banker to the commercial banks by holding a proportion of their cash reserves. These are part of minimum reserves assets. This enables the banks to settle any indebtedness to each other created by the daily clearing of cheques, by transfer between their accounts at the central bank.
As the banker to other banks, the central bank gives direct advances against the government securities or bill rediscounting facilities to other banks. The latter are required to maintain a portion of their total deposits (from 3% to 15% of total deposits as in India) as reserve at the central bank. By varying this reserve ratio, the central bank can control the advances of other banks.
Function # 4. Control of Bank Credit:
The central bank of a country controls the bank advances or bank credit through its various methods of control such as the bank rate policy, open market operations, variable reserve ratio, selected credit controls, etc., for both internal and external stability. This is perhaps the most essential function of the central bank.
Function # 5. The Lender of the Last Resort:
The central bank is the ultimate lender to the money market of a country. During any crisis or panic, it gives all sorts of funds to other banks to enable them to tide over the crisis. This function enables the central bank to help the money market carry on in times of difficulty.
Function # 6. Control and Supervision of Other Banks:
The central bank controls and supervises the operations of other banks through licensing, inspection of bank accounts, bank mergers, etc.
The basic objectives is to limit, to the maximum extent possible, the risks to a bank’s capital from mismatched or over-concentrated investment or lending. The central bank always tries to ensure that a commercial bank makes judicious investment through a rational allocation of its loanable funds among different sectors.
Function # 7. The Custodian of the Nation’s Gold and Foreign Exchange Reserve:
The central bank keeps the nation’s gold and foreign exchange reserve under its direct supervision.
Function # 8. Maintenance of the Foreign Exchange Rates:
The central bank is required to maintain the rate of exchange i.e., the external value of the currency. It has to conduct foreign exchange operations at some specified exchange rates. It also exercises control of foreign exchange. This is necessary for maintaining stability in the value of rupee in terms of other currencies.
Function # 9. Protection of Gold and Foreign Currency Reserves:
These reserves are required as a ‘cushion’ in the event of a balance of payments deficit. They would be used to help finance the deficit. In the case of a balance of payments surplus the central bank would add to the reserves. Thus reserves fall during balance of payments deficit and rise during surplus. The central bank also administers government regulations as regards supply of and demand for foreign exchange and arranges loans (possibly from the IMF) to supplement the reserves.
Function # 10. Operation of the Government’s Monetary Policy:
The central bank is responsible for the management of the government’s monetary (credit) policy.
Monetary policy refers to the policy of the government regarding money matters of a country. It is concerned with the monetary management including the expansion and contraction of money supply. The government of a country, more precisely the central bank of a country, must decide the aims relating to the monetary management. The monetary policy is mainly carried out by various traditional and selective instruments of credit control.
Function # 11. Stability of the Value of Money:
The central bank has the duty of keeping both internal and external value of the country’s currency through various measures.
Function # 12. Strengthening the Banking Structure:
The central bank is required to take various steps — such as deposits insurance, extension of banking facilities in the unbanked areas, etc. — for strengthening the country’s banking structure.
Function # 13. Special Role in a Developing Country:
The central bank has a special role to play in a developing economy like that of India in promoting growth with stability, providing special credit for agriculture and industry, etc.
Function # 14. Other Functions:
The central bank also acts as the clearing house, publishes valuable reports and data, and performs various other functions relating to the management and development of the economy.
The functions of the central bank have a great importance in the economy of a country. The soundness of the monetary and banking system of a country depends in a large measure on the efficient discharge of these functions by the central bank.