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Definition of Central Bank
Definition of Central Bank
2. What are the important roles played by Central Bank in developing countries?
In the developing countries, the central bank has to play a much wider role. Besides performing the
traditional functions, the central bank has to undertake responsibility of economic growth with stability
in these economies. The central bank performs the following developmental and promotional functions
in the developing countries:
1. Traditional Functions: The central banks in the developing countries perform both traditional and
non-traditional functions. The traditional functions of the central bank are: having the monopoly of
note-issue; acting as banker to the government; serving as bankers' bank; functioning as the lender of
the last resort; controlling and regulating the credit; and maintaining the external stability.
2. Economic Growth: The central banks in the developing countries should aim at promoting the
process of economic growth. Economic growth requires sufficient financial resources. The central bank
can ensure adequate monetary expansion in the country.
3. Internal Stability: Along with the objective of economic growth, the central bank should also
attempt to maintain internal price stability. The developing countries are susceptible to inflationary
pressures mainly due to supply -in elasticity in the short period. The central bank should adopt such a
monetary policy that can control inflationary tendencies and ensure price stability.
4. Development of Banking System: The developing and underdeveloped countries do not have well-
developed banking system. In such an economy, the central bank should not only take measures to
develop an integrated commercial banking system, but also should not hesitate undertaking directly the
commercial banking functions.
5. Development of Financial Institutions: Development of the leading sectors of the economy such as
agriculture, industry, foreign trade, etc. requires long-term finances. For this, the specialized financial
institutions should be established which provide term-loans to these sectors.
6. Credit Control: Through its various credit control instruments (i.e., bank rate, variable cash-reserve
ratio, etc.) and by providing discounting facilities to the commercial banks, the central bank exercises
full control over the activities of commercial banks. This creates public confidence in the banking
system and helps in the development of banking habits of the people.
7. Proper Interest Rate Structure: The central bank can help in establishing a suitable interest rate
structure to influence the direction of investment in the country. In underdeveloped countries, a policy
of low interest rate is necessary for encouraging investment and promoting development activities.
8. Other Promotional Roles:
The central bank can provide a number of other promotional facilities. For example, (a) it can adopt
policies to provide help to the various priority sectors, such as agriculture, cooperative sector, small
scale sector, export sector, etc. (b) it can publish information regarding the state of the economy and
promote research in money and banking.
In short, the central bank has to play not only regulatory, but also developmental role in the developing
countries.
Prepared by: Md. Shahbub Alam Sony
Dept. of Finance and Banking
The central bank of a country enjoys a special status in the banking structure of the country. The
principles on which a central bank is run differ from the ordinary banking principles. They are as
follows:
1. An ordinary bank is run for profits. On the other hand, A central bank is primarily meant to promote
the financial and economic stability of the country.”, De Kock says, “The guiding principle of a central
bank is that it should act only in the public interest and for the welfare of the country and without
regard to profit as primary consideration”. Earning of profit for a central bank is a secondary
consideration.
2. The central bank is not a profit hunting institution. It does not act as rival of other banks. In fact, it is
a monetary authority of the country and has to function in a manner as to promote economic stability
and development.
3. The central bank is a reservoir of credit and a lender of last resort. All other banks and financial
houses can look it for accommodation at a price. But the central bank cannot rely on any other
institution to come to its aid.
4. The central bank must follow an active policy. It should not be merely an idle spectator when
something goes wrong with the credit machinery of the nation. It must take active steps to remedy the
situation. Such as (a) the manipulation of the bank rate policy; (b) the open market operations.
5. For the efficient of discharge of its functions, the central bank is provided with special equipment.
Such as (a) it is given the monopoly of the notes issue, (b) it is made a banker to the government, (c)it
is a banker’s bank.
6. Finally, a central bank should not be subservient to any political party. It must be independent of all
political influence so that it can act freely in the best interests of the nation as whole.
Credit control is the regulation of credit by the central bank for achieving some definite objectives. The
important objectives of credit control are given below:
1. Price Stability: Price Stability causes disturbances and maladjustments in the economic system and
serious social consequences. Hence, price stability is an important objective of credit control policy.
The central bank, by regulating the supply of credit in accordance with the commercial needs of the
people, can bring about price stability in the country.
2. Exchange Rate Stability: Exchange rate stability can also be an objective of credit control policy.
Instability in the exchange rates is harmful for the foreign trade of the country. Thus, the central bank,
in the countries largely dependent upon foreign trade, should attempt to eliminate the fluctuations in
the foreign exchange rates through its credit control policy.
3. Economic Stability: Operation of the business cycle brings instability in a capitalist economy. The
objective of the credit control policy of the central bank should be to eliminate cyclical fluctuations and
ensure economic stability in the economy.
4. Economic Growth: The main objective of credit control policy in the underdeveloped countries
should be the promotion of economic growth within the shortest possible time. These countries
generally suffer from the deficiency of financial resources. Hence, the central banks in these countries
should solve the problem of financial scarcity through planned expansion of bank credit.
3. Maximization of Employment: Unemployment is economically wasteful and socially undesirable.
Therefore economic stability with full employment and high per capita income has been considered as
an important objective of credit control policy of a country.
5. Stabilization of Money Market: Another objective of the central bank's credit control policy is the
stabilization of the money market as to reduce the fluctuations in the interest rates to the minimum.
Credit control should be exercised in such a way that the equilibrium in the demand and supply of
money should be achieved at all times.
Prepared by: Md. Shahbub Alam Sony
Dept. of Finance and Banking
There are several difficulties in the way of the central bank being able to control credit:
1. Bank credit is not the only form of credit. There is commercial credit like book credit, bills
of exchange and promissory notes. Over these, the central bank has little control. They are as much
purchasing power as any other form of credit.
2. Even as regards bank credit, all banks of the country do not have direct relations with the central
hank. For instance, in the U.S.A. one-half of the commercial banks with one-fifth of resources
arc outside the Federal Reserve System.
3. Even if all banks were member-banks, commercial banks may not always co-operate with the central
banks and may not follow its lead. Such co-operation, as we shall see, in indispensable for a
successful control of credit.
4. There are non-banking elements in the financial structure of a country. Among these arc the various
circumstances that affect the temper of the business community. These are beyond the scope of central
banking action.
5. The central bank cannot control the ultimate use to which credit may be put. For instance, strictly
commercial loans may be used for speculative purposes.
However, this does not mean that any attempt to control credit on the part of the central bank is bound
to fail. These are the limitations to which the action of the central bank is subject.
Short Note
Market rate: The market rate is the rate of discount prevailing in the money market among the other
lending institutions.
Rate of interest: The ‘rate of interest’ is the rate which the commercial banks pay to those who keep
deposits with them.
SLR: The statutory liquidity ratio refers to that proportion of aggregate deposits which the commercial
banks are required to keep with themselves in a liquid form. The commercial banks generally make use
of this money to purchase the government securities. Thus, the statutory liquidity ratio, on the one hand
is used to siphon off the excess liquidity of the banking system, and on the other it is used to mobilize
revenue for the government. Presently, SLR is 19.5%
CRR: Commercial banks are required under the law to keep a certain percentage of their total deposits
with the central bank in the form of cash reserves. This is called CRR. Presently, CRR is 6.5%.
Prepared by: Md. Shahbub Alam Sony
Dept. of Finance and Banking