Central Banking details.

CENTRAL BANKING

 The central bank is the apex bank in a country. It is called by different names in different country. It is the Reserve Bank of India in India, The bank of England in England, The Federal Reserve System in America, and the bank of France in France the risk bank in Sweden etc.

DEFININITION OF CENTRAL BANK

v W.A Shaw defines “a central bank as a bank which control credit”.

v According to A.C.L Day, a central bank is “to help control and stabilize the monetary and

banking system”.

 

Objectives of Central Banking

 

1.     Monetary Stability:

•        Central banks often prioritize maintaining price stability and controlling inflation within a target range. They aim to ensure the purchasing power of the currency remains relatively stable over time, fostering confidence in the economy.

2.     Economic Growth and Stability:

•        Central banks play a role in promoting sustainable economic growth by employing monetary policy tools to manage interest rates, money supply, and credit availability. They strive to achieve balanced economic growth while avoiding excessive volatility.

3.     Full Employment:

•        Central banks often consider employment levels in their objectives. While they might not directly control employment, they use monetary policy to influence economic conditions that can impact job creation and unemployment rates.

4.     Financial Stability:

•        Maintaining stability in the financial system is a crucial objective. Central banks monitor and manage systemic risks within the banking and financial sectors to prevent crises and ensure the smooth functioning of the financial system.

5.     Currency Stability and Exchange Rate Management:

•        Central banks aim to ensure stability in the value of the national currency. They might intervene in the foreign exchange market to stabilize exchange rates or address situations that might affect the currency's value.

6.     Regulation and Supervision of Banks:

•        Central banks regulate and supervise banks and financial institutions to maintain a sound and healthy banking system. They establish regulations, conduct inspections, and set guidelines to ensure financial institutions operate prudently and comply with established standards.

7.     Lender of Last Resort:

•        Central banks act as lenders of last resort to provide liquidity support to banks facing temporary liquidity shortages. This helps prevent bank runs or systemic failures and maintains confidence in the banking system.

8.     Conducting Monetary Policy:

•        One of the primary functions of central banks is formulating and implementing monetary policy. They use tools like open market operations, reserve requirements, and discount rates to control the money supply and influence economic conditions.

9.     Supporting Government Objectives:

•        Central banks collaborate with governments to achieve broader economic and financial objectives. They might provide advice, support fiscal policies, and work towards shared economic goals.

 

FUNCTIONS OF CENTRAL BANKS

1.     Regulator of Currency: The central bank is legally empowered to issue currency notes. The central bank is charged with the responsibility of marinating price stability, inflation level i.e. the domestic value of its money as well as its external value. The central bank has the monopoly power of the note issue to regulate the supply of legal tender money.

2.     Banker to the Government: The central bank act as the banker, financial agent and advisor to the government. The surplus money of the government is kept with the central bank. It lends money both the banks. Its helps the government to tide over the time gap between their expenditure and collection of taxes. The central banks also under take to provide the government with necessary foreign exchange for making payment aboard.

3.     Banker to the Banks: The central banks act as the banker‟s bank. As such it performs the following functions. Custodian of cash reserves of commercial banks. The central bank keeps the deposits of the central and state government and makes payments on behalf of governments. But it does not pay interest on government deposits

4.     Custody and management of Foreign Exchange Reserves: The central bank keeps and manages the foreign exchange of the country. It is an official reservoir of gold and foreign currencies. It sells gold at fixed prices to the monetary authorities of other countries. It also buyer and sells foreign currencies at international price. Further it fixes the exchange rates of the domestic currency in terms of foreign currencies.

5.     Lender of the Last Resort: De Kock regards this function as a sine qua non of central banking. It acts as lender of the last resort through discount house on the basis of treasury bills, government. Securities and bonds at “the front door”. Thus the central bank as lender of the last resort is a big source of cash and also influences prices and market rates.

6.     Clearing house for Transfer and Settlement: The central bank acts as a clearing house for transfer and settlement of natural claims of commercial banks. Since the central bank holds reserves of commercial banks, it transfers funds from one bank to other banks to facilitate clearing of cheques. To transfer and settle claims of one bank upon others, the central bank operates a separate department in big cities and trade centers. This department is known as the “clearing house” and it renders the service free to commercial banks.

7.     Controller of Credit: The central bank is empowered to control the credit creation of the commercial bank. The commonly used method of credit control are bank rate policy, open market operation, variation of cash reserve credit rationing, variation of margin requirement and regulations of consumer‟s credit.

Impact of central bank on economic growth and development

1.     Monetary Policy Tools: Central banks utilize monetary policy tools such as interest rates, reserve requirements, and open market operations to manage the money supply and credit availability. By adjusting these tools, central banks aim to stimulate economic growth by encouraging borrowing and investment or curbing inflationary pressures.

2.     Price Stability: Central banks prioritize maintaining price stability and controlling inflation. Stable prices encourage consumer confidence, business investment, and long-term planning, fostering a conducive environment for economic growth.

3.     Financial Stability: Central banks oversee the stability of the financial system by regulating banks and financial institutions. They mitigate risks, prevent financial crises, and maintain confidence in the banking sector, which is essential for sustainable economic development.

4.     Interest Rate Management: Central banks influence interest rates, affecting borrowing costs for businesses and individuals. Lower interest rates typically encourage borrowing for investment and consumption, stimulating economic activity and growth.

5.     Lender of Last Resort: Central banks act as lenders of last resort, providing liquidity to banks during financial crises or liquidity shortages. This function helps maintain confidence in the banking system and prevents systemic failures, supporting economic stability.

6.     Exchange Rate Management: Central banks may intervene in the foreign exchange market to manage exchange rates. Stable exchange rates can facilitate international trade and investment, contributing to economic growth.

7.     Supporting Government Objectives: Central banks collaborate with governments to achieve broader economic goals. They might provide advice, support fiscal policies, and work towards shared economic objectives.

8.     Influence on Investor and Consumer Confidence: Central bank policies and actions significantly impact investor and consumer confidence. Confidence in the stability and credibility of monetary policies can drive investment, spending, and economic growth.

9.     Long-Term Planning and Economic Predictability: By providing a stable monetary environment, central banks facilitate long-term planning for businesses and individuals. Predictability in economic conditions supports investment and growth-oriented decisions.

  Recent trends in commercial banks and central banks

Trends in Commercial Banks:

1.     Digital Transformation: Commercial banks were increasingly investing in digitalization to improve customer experience and streamline operations. This involved enhancing online and mobile banking services, adopting fintech collaborations, and investing in innovative technologies like AI, machine learning, and blockchain.

2.     Focus on Customer-Centric Services: Banks were prioritizing personalized and customer-centric services. They aimed to provide tailored financial solutions, responsive customer service, and improved user experiences to meet evolving customer expectations.

3.     Sustainability and ESG Integration: Many commercial banks were incorporating Environmental, Social, and Governance (ESG) criteria into their operations and investment decisions. They were increasingly focusing on sustainable finance, responsible lending, and supporting initiatives related to climate change and social responsibility.

4.     Risk Management and Compliance: Heightened regulatory requirements and increasing cybersecurity threats compelled banks to emphasize risk management practices and compliance standards. They were investing in robust risk assessment frameworks, cybersecurity measures, and regulatory technology to ensure adherence to regulatory guidelines.

5.     Partnerships and Collaborations: Banks were exploring partnerships and collaborations with fintech companies and other non-banking entities to enhance service offerings, expand market reach, and innovate financial products.

Trends in Central Banks:

1.     Unconventional Monetary Policies: Many central banks continued to implement unconventional monetary policies, such as quantitative easing (QE) and negative interest rates, to address economic challenges, stimulate growth, and combat deflationary pressures.

2.     Digital Currencies and CBDCs: Several central banks were exploring or experimenting with Central Bank Digital Currencies (CBDCs). They were researching the potential benefits, risks, and implications of introducing digital currencies for retail and wholesale transactions.

3.     Policy Response to COVID-19 Pandemic: Central banks played a pivotal role in providing monetary stimulus and support measures to mitigate the economic impact of the COVID-19 pandemic. This included interest rate cuts, liquidity injections, asset purchase programs, and loan guarantee schemes.

4.     Climate Risk Consideration: Some central banks were increasingly considering climate-related risks in their supervisory and regulatory frameworks. They were exploring ways to integrate climate risk assessments into financial stability analyses and prudential regulations.

5.     Enhanced Communication and Transparency: Central banks were focusing on improved communication strategies and transparency in their policy decisions. Many central banks aimed to enhance forward guidance, clearly communicate policy intentions, and maintain credibility and predictability in their actions.

DIFFERENT BETWEEN CENTRAL BANKING AND COMMERCIAL BANKING

Sl.No	BASIC	CENTRAL BANKING	COMMERCIAL BANKING
1	Position of the bank	It is the apex bank in the banking of country	It is part of the banking system
2	Ownership	It is government owned bank	Commercial bank    include public sector bank. Also foreign owned bank
3	Basic motive	It aims at economic growth and price stability and has no profit motive	They aim as maximization of  profit
4	Dealing with the public	Central      bank    does    not    deal directly with the public	They deal directly with the general public
5	Competition	Central bank does not compete with commercial bank	Commercial bank compete among themselves
6	Relationship	The relationship between the central bank and commercial bank is unique. The central bank has power to exercise control over bank.	Commercial banks are functioning at the same level. They cannot exercise control over others except on their subsidiaries
7	Government transaction	Central bank usually act as advisor to the government and also conducts government transaction	Public sector bank particularly undertakes government transaction. However, other commercial banks also precluded from such function.
8	Power of note issue	The     central    bank    has    the sole authority to issue currency note.	Commercial banks cannot issue currency notes
9	Dealing        with                      foreign currency	Central bank has the responsibility to maintain the stability of foreign exchanges rates	They do        not       have    any            such responsibility
10	Role of banking	Central bank function as the banker to the government	They are functioning as the banker to general public
11	Basic function	Central bank acts as the bankers and lender of last resort to the commercial banks	They do not have such roles and status
12	Responsibility	Central bank responsibility to hold the price line and inflation rate	The commercial banks do not have responsibility