Central Bank and It’s Functions

A central bank plays an important role in monetary and banking

system of a country.

It is responsible for maintaining financial sovereignty and

economic stability of a country, especially in underdeveloped
countries.

It issues currency, regulates money supply, and controls different

interest rates in a country. Apart from this, the central bank
controls and regulates the activities of all commercial banks in a
country.
Some of the management experts have defined central bank in
different ways, which are as follows:

According to Samuelson, “Every Central Bank has one function.

It operates to control economy, supply of money and credit.”

According to Vera Smith, “The primary definition of Central

Bank is the banking system in which a single bank has either a
complete or residuary monopoly of note issue.”

According to Kent, “Central Bank may be defined as an

institution which is charged with the responsibility of managing
the expansion and contraction of the volume of money in the
interest of general public welfare.”

According to Bank of International Settlement, “A Central Bank

is the bank in any country to which has been entrusted the duty of
regulating the volume of currency and credit in that country.”

Bank of England was the world’s first effective central bank that
was established in 1694. As per the resolution passed in Brussels
Financial Conference, 1920, all the countries should establish a
central bank for interest of world cooperation. Thus, since 1920,
central banks are formed in almost every country of the world. In
India, RBI operates as a central bank.
Functions of Central Bank:

The central bank does not deal with the general public directly. It
performs its functions with the help of commercial banks. The
central bank is accountable for protecting the financial stability
and economic development of a country.

Apart from this, the central bank also plays a significant part in
avoiding the cyclical fluctuations by controlling money supply in
the market. As per the view of Hawtrey, a central bank should
primarily be the “lender of last resort.”

On the other hand, Kisch and Elkins believed that “the

maintenance of the stability of the monetary standard” as the
essential function of central bank. The functions of central bank
are broadly divided into two parts, namely, traditional functions
and developmental functions.

PRIMARY FUNCTIONS
Refer to functions that are common to all central banks in the
world.
(i) Bank of issue:

Possesses an exclusive right to issue notes (currency) in every

country of the world. In the initial years of banking, every bank
enjoyed the right of issuing notes. However, this led to a number
of problems, such as notes were over-issued and the currency
system became disorganized. Therefore, the governments of
different countries authorized central banks to issue notes. The
issue of notes by one bank has led to uniformity in note
circulation and balance in money supply.

(ii) Government’s banker, agent, and advisor:

Implies that a central bank performs different functions for the

government. As a banker, the central bank performs banking
functions for the government as commercial banks performs for
the public by accepting the government deposits and granting
loans to the government. As an agent, the central bank manages
the public debt, undertakes the payment of interest on this debt,
and provides all other services related to the debt.

As an advisor, the central bank gives advice to the government

regarding economic policy matters, money market, capital
market, and government loans. Apart from this, the central bank
formulates and implements fiscal and monetary policies to
regulate the supply of money in the market and control inflation.

(iii) Custodian of cash reserves of commercial banks:

Implies that the central bank takes care of the cash reserves of
commercial banks. Commercial banks are required to keep certain
amount of public deposits as cash reserve, with the central bank,
and other part is kept with commercial banks themselves.

The percentage of cash reserves is deeded by the central bank! A

certain part of these reserves is kept with the central bank for the
purpose of granting loans to commercial banks Therefore, the
central bank is also called banker’s bank.

(iv) Custodian of international currency:

Implies that the central bank maintains a minimum reserve of

international currency. The main aim of this reserve is to meet
emergency requirements of foreign exchange and overcome
adverse requirements of deficit in balance of payments.
(v) Bank of rediscount:

Serve the cash requirements of individuals and businesses by

rediscounting the bills of exchange through commercial banks.
This is an indirect way of lending money to commercial banks by
the central bank. Discounting a bill of exchange implies acquiring
the bill by purchasing it for the sum less than its face value.

Rediscounting implies discounting a bill of exchange that was

previously discounted. When owners of bill of exchange are in
need of cash they approach the commercial bank to discount these
bills. If commercial banks are themselves in need of cash they
approach the central bank to rediscount the bills.

(vi) Lender of last resort:

Refer to the most crucial function of the central bank. The central
bank also lends money to commercial banks. Instead of
rediscounting of bills, the central bank provides loans against
treasury bills, government securities, and bills of exchange.

(vii) Bank of central clearance, settlement, and transfer:

Implies that the central bank helps in settling mutual indebtness

between commercial banks. Depositors of banks give checks and
demand drafts drawn on other banks. In such a case, it is not
possible for banks to approach each other for clearance,
settlement, or transfer of deposits.

The central bank makes this process easy by setting a clearing

house under it. The clearing house acts as an institution where
mutual indebtness between banks is settled. The representatives
of different banks meet in the clearing house to settle inter-bank
payments. This helps the central bank to know the liquidity state
of the commercial banks.

(viii) Controller of Credit:

Implies that the central bank has power to regulate the credit
creation by commercial banks. The credit creation depends upon
the amount of deposits, cash reserves, and rate of interest given
by commercial banks. All these are directly or indirectly
controlled by the central bank. For instance, the central bank can
influence the deposits of commercial banks by performing open
 market operations and making changes in CRR to control various
economic conditions.

Developmental / Promotional Functions of RBI

Along with the routine traditional functions, central banks especially
in the developing country like India have to perform numerous
functions. These functions are country specific functions and can
change according to the requirements of that country. The RBI has
been performing as a promoter of the financial system since its
inception. Some of the major development functions of the RBI are
maintained below.
1. Development of the Financial System: The financial system
comprises the financial institutions, financial markets and financial
instruments. The sound and efficient financial system is a
precondition of the rapid economic development of the nation. The
RBI has encouraged establishment of main banking and nonbanking
institutions to cater to the credit requirements of diverse sectors of
the economy.
2. Development of Agriculture: In an agrarian economy like ours, the
RBI has to provide special attention for the credit need of
agriculture and allied activities. It has successfully rendered service
in this direction by increasing the flow of credit to this sector. It has
earlier the Agriculture Refinance and Development Corporation
(ARDC) to look after the credit, National Bank for Agriculture and
Rural Development (NABARD) and Regional Rural Banks (RRBs).
3. Provision of Industrial Finance: Rapid industrial growth is the key
to faster economic development. In this regard, the adequate and
timely availability of credit to small, medium and large industry is
very significant. In this regard the RBI has always been instrumental
in setting up special financial institutions such as ICICI Ltd. IDBI,
SIDBI and EXIM BANK etc.
4. Provisions of Training: The RBI has always tried to provide
essential training to the staff of the banking industry. The RBI has
set up the bankers' training colleges at several places. National
Institute of Bank Management i.e NIBM, Bankers Staff College i.e
 BSC and College of Agriculture Banking i.e CAB are few to
mention.
5. Collection of Data: Being the apex monetary authority of the
country, the RBI collects process and disseminates statistical data on
several topics. It includes interest rate, inflation, savings and
investments etc. This data proves to be quite useful for researchers
and policy makers.
6. Publication of the Reports: The Reserve Bank has its separate
publication division. This division collects and publishes data on
several sectors of the economy. The reports and bulletins are
regularly published by the RBI. It includes RBI weekly reports, RBI
Annual Report, Report on Trend and Progress of Commercial Banks
India., etc. This information is made available to the public also at
cheaper rates.
7. Promotion of Banking Habits: As an apex organization, the RBI
always tries to promote the banking habits in the country. It
institutionalizes savings and takes measures for an expansion of the
banking network. It has set up many institutions such as the Deposit
Insurance Corporation-1962, UTI-1964, IDBI-1964, NABARD-
1982, NHB-1988, etc. These organizations develop and promote
banking habits among the people. During economic reforms it has
taken many initiatives for encouraging and promoting banking in
India.
8. Promotion of Export through Refinance: The RBI always tries to
encourage the facilities for providing finance for foreign trade
especially exports from India. The Export-Import Bank of India
(EXIM Bank India) and the Export Credit Guarantee Corporation of
India (ECGC) are supported by refinancing their lending for export
purpose

Supervisory Functions of RBI

The reserve bank also performs many supervisory functions. It has
authority to regulate and administer the entire banking and financial
system. Some of its supervisory functions are given below
1. Granting license to banks: The RBI grants license to banks for
carrying its business. License is also given for opening extension
counters, new branches, even to close down existing branches.
2. Bank Inspection: The RBI grants license to banks working as per the
directives and in a prudent manner without undue risk. In addition to
this it can ask for periodical information from banks on various
components of assets and liabilities.
3. Control over NBFIs: The Non-Bank Financial Institutions are not
influenced by the working of a monitory policy. However, RBI has
a right to issue directives to the NBFIs from time to time regarding
their functioning. Through periodic inspection, it can control the
NBFIs.
4. Implementation of the Deposit Insurance Scheme: The RBI has set
up the Deposit Insurance Guarantee Corporation in order to protect
the deposits of small depositors. All bank deposits below Rs. One
lakh are insured with this corporation. The RBI work to implement
the Deposit Insurance Scheme in case of a bank failure
RESERVE BANK OF INDIA

Establishment
The Reserve Bank of India was established on April 1, 1935 in
accordance with the provisions of the Reserve Bank of India Act,
1934.
The Central Office of the Reserve Bank was initially established in
Kolkata but was permanently moved to Mumbai in 1937. The
Central Office is where the Governor sits and where policies are
formulated.
Though originally privately owned, since nationalisation in 1949,
the Reserve Bank is fully owned by the Government of India.
Preamble
The Preamble of the Reserve Bank of India describes the basic
functions of the Reserve Bank as:
"to regulate the issue of Bank notes and keeping of reserves with
a view to securing monetary stability in India and generally to
operate the currency and credit system of the country to its
advantage; to have a modern monetary policy framework to
meet the challenge of an increasingly complex economy, to
maintain price stability while keeping in mind the objective of
growth."