CENTRAL BANK

 Central Bank and its functions

A central bank is an independent national authority that conducts monetary policy, regulates
banks, and provides financial services as well as economic research. Its goals are to stabilize
the nation's currency, keep unemployment low, and prevent inflation.
A Central Bank manages state’s currency, money supply and interest rate. It also usually
oversees the commercial banking system in their respective country. Like State Bank of
Pakistan
Functions:
A Central Bank has two broad functions basically. The First one is Traditional Function
and the Second one is Developmental Functions. Which also broken down further in
various smaller functions.
a) Traditional Functions:
Firstly, the Traditional Functions that are common to all central banks in the world.
1. Issuance of Money or Bank Notes:
The Central Bank have the responsibility of issuing money or bank notes and coins of the
respective country and ensure people have faith in notes and coins which are printed by
Central Bank. This is also an important responsibility and function because printing too much
money can cause inflation.
2. Lender of Last Resort to Commercial Banks:
This is also one of the important function as it helps to maintain confidence in banking
system. If banks get into liquidity shortages, then the central bank is able to lend the
commercial bank sufficient funds to avoid the bank running short. If a bank has a liquidity
shortage, then people would lose confidence and want to withdraw their money from bank.
Having a lender of last resort means that we don’t expect a liquidity crisis with our banks,
therefore people have high confidence in keeping our savings in banks.
3. Bank of Central clearance, settlement, and transfer:
In settlement between different commercial banks the Central Bank acts as a clearing house
clearing all matters of inter-banking payments. And by this process central bank knows the
liquidity or monetary state of commercial banks.
4. Credit Controller:
The central Bank has the authority to control or regulate the credit creation of commercial
banks. The Credit creation depends on the amount of deposits, cash reserves and rate of
interests which are given and monitored by central banks.
5. Bank of rediscount:
As this is an indirect pattern of lending money to commercial banks by the central bank.
With the help of commercial banks, the central bank rediscount the bill of exchange. Like by
discounting the bill of exchange, purchases it for the sum less than its stated value.
When owner of the bill of exchange need cash they go towards the commercial banks for
discounting this bill but if the commercial banks don’t have the cash or they themselves in
need of cash they go towards the central bank to rediscount these bills.
6. Act as Advisor, Government’s Bankers and agents:
Central bank executes different functions for the government. The central Bank is performing
for government and is similar to the commercial banks which are performing different
functions to the public. The difference is that the central bank provides and gives all those
services and facilities to the government of a respective country. The central bank granting
loans and accepting debts of government. The central bank also plays a role of an agent by
managing public debts, undertaking the payment of interest on this debt and provide all other
services related to debt.
7. Custodian and keeper of cash reserves of commercial banks:
The commercial banks have need of keeping certain amount of public debt as a cash reserve,
with the central bank and keep some part of it with themselves (commercial banks). The
central bank keeps check and balance of cash reserve and also took care of these cash reserve
with commercial banks.
8. Custodian of international currency:
The central bank has to keep and maintain a reserve of international currency as in need of
any exigency of foreign exchange need to overcome any hazard and to also counter adverse
requirements of deficit in balance of payments.
b) Developmental Functions:
1. Influencing Money Market and Capital Market:
The central bank assist in managing financial markets (Capital Markets and Money Market).
By controlling of these financial markets the central bank maintains the country’s economic
growth and stability.
2. Collecting Statistical Data:
The central bank collects and analyze data associated with banking, currency, and foreign
exchange position in a country. The data is thoroughly helpful for the policymakers,
economists and researchers.

 Central bank’s balance sheet and monetary base

A central bank’s balance sheet assets include securities in the form of treasuries, net
foreign exchange reserves, net government balances, net central bank operations. Central
bank’s balance sheet liabilities include bank notes or currencies, all commercial banks
reserves and capital and reserves.
There are basically two sides of central bank balance sheet, the one is liability side where
three components of liability are discussed and defined below:
a. Banknotes:
The central bank came to know that how much banknotes are issued which are in circulation
or held by the commercial banks and in the ATM. The commercial banks print these notes in
exchange for the reserve balances held at the central bank. Any central bank usually reduces
electronic reserves and increases cash bank notes. Also the liability side has the overnight
balances that the commercial banks in an account with the central bank which plays an
important role in determining the monetary policy of the country.
b. All commercial banks reserves:
Commercial banks have to reserve their cash to some particular ratio with the central bank.
With this reserve the central bank helps commercial banks in any hazardous situation.
c. Capital
The Capital of a central bank is also considered to be a liability as unlike a private
corporation it aims at achieving the policy goals using this capital.
Whereas on the second side is Assets which includes:
a. Foreign Assets:
The foreign assets are kept in the form of foreign exchange and it involves the domestic and
non-domestic currencies which are held by the central bank. The foreign assets are kept for
three main factors, for intervention; for overcoming foreign debt; and to cover trade balances.
b. Government Balance:
These are the funds deposit in the central bank by the government of that country. It may be
increased by collection of taxes or decreased by making expenditures such as increasing the
reserves for commercial banks.
c. Net central bank operations:
The net central bank operations that are useful in determining the amount of commercial
bank reserves by looking at the changes in the remaining elements of the balance sheet.
supply liquidity, absorb and securities impact these operations.

 Monetary Base:
A monetary base is the total amount of money or currency circulated either in general in the
hand of public, in commercial banks deposits or in ATM’s held in the central bank reserves.
With this the central bank can measure and control the velocity of money in the country.
This measure of the money supply typically only includes the most liquid currencies; it is
also known as the "money base”.