SUBMITTED BY

ZARA ABRO (1711332)

TOPIC OF ASSIGNMENT

ROLE OF CENTRAL BANK

SUBMITTED TO

SIR HUSSAIN KHUWAJA

DATED

05-JUNE-2020

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 ROLE OF CENTRAL BANK

Central Bank Definition:

“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 International Settlement.

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.”

Functions of Central Bank Central Bank

Traditional Functions and Non-Traditional Functions

Traditional Functions: Which are generally performed by central banks all over the world, are
classified into two groups;

Primary Functions: including issue of notes, regulation of financial system, and conduct of monetary
policy

Secondary Functions: including management of public debt, management of foreign exchange, advising
the government on policy matters, and maintaining close relationships with the international financial
institutions

Non-Traditional Functions: these functions are performed by the Central Bank include
development of financial frame work, provision of training facilities to bankers, and provision of credit to
priority sectors.

ROLE OF CENTRAL BANK:

The main role of a central bank is common all over the world. But the scope and content of policy
objectives may vary from country to country and from period to period depending on the economic
situations of the respective country. Generally all the central banks aim at achieving economic stability
along with a high growth rate and a favorable external payment position through proper monetary
management.

The common roles of central banks are as below:

1. Regulator of currency: The issue of paper money is the most important function of a central
bank. The central bank is the authority to issue currency for circulation, which is a legal tender money.

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The issue department of the central bank has the responsibility to issue notes and coins to the commercial
banks. The central bank regulates the credit and currency according to the economic situation of the
country. In the methods of note issue, the central bank is required to keep a certain amount or a fixed
proportion of gold and foreign securities against the total notes issued. Having the monopoly of note
issue, central bank gains advantages as Ensuring uniformity of the notes issued and a proper control over
the supply of money can be exercised. Bring stability in the monetary system and creates confidence
among the public. Government is able to earn profits from printing currencies.

2. Banker, Agent and Adviser to the Government: The central bank of the country acts
as the banker, fiscal agent and advisor to the government. As a banker, it keeps the deposits of the central
and state governments and makes payments on behalf of governments. It buys and sells foreign currencies
on behalf of the government. It keeps the stock of gold of the country. As a fiscal agent, the bank makes
short-term loans to the government for a period not exceeding 90 days. It floats loans and advances to the
State governments and local bodies. It manages the entire public debt on behalf of the government. As an
adviser, the bank gives useful advice to the governments on important monetary and economic problems
like devaluation, foreign exchange policy and budgetary policy.

3. Custodian of cash Reserves of commercial banks: Commercial banks are required to

keep a certain percentage of cash reserves with the central bank. On the basis of these reserves, the central
bank transfers funds from one bank to another to facilitate the clearing of cheques.

4. Custodian and Management of Foreign Exchange reserves: The central bank

keeps and manages the foreign exchange reserves of the country. It fixes the exchange rate of the
domestic currency in terms of foreign currencies. If there are any fluctuations in the foreign exchange
rates, it may have to buy and sell foreign currencies in order to minimize the instability of exchange rates.

5. Lender of the last resort: By giving accommodation in the form of re-discounts and collateral
advances to commercial banks, bill brokers and their financial institutions, the central bank acts as the
lender of the last resort. The central bank lends to such institutions in order to help them when they are
faced with difficult situations so as to save the financial structure of country from collapse.

6. Clearing house Function: Function The central bank acts as a 'clearing house' for other banks
and mutual obligations are settled through the clearing system. Since it holds cash reserves of commercial
banks, it is easier for the central bank to act as a 'clearing house'.

7. Controller of credit: The most important function of the central bank is to control the credit
creation power of commercial banks in order to control inflationary and deflationary pressures within the
economy.

The basic and important needs of credit control in the economy are;

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  To encourage the overall growth of the "priority sector" i.e. those sectors of the economy which is
recognized by the government as "prioritized" depending upon their economic condition or
government interest.
 To keep a check over the channelization of credit so that credit is not delivered for undesirable
purposes.
 To achieve the objective of controlling inflation as well as deflation.
 To boost the economy by facilitating the flow of adequate volume of bank credit to different
sectors.
 To develop the economy.

For this purpose, the central bank adopts: 1. Quantitative methods 2. Qualitative(selective) methods.

QUANTIATIVE METHOD: These help the quantity of credit created and the money in
circulation the following method are used: The quantitative measures of credit control are as follows:

1. Bank Rate Policy The bank rate is the Official interest rate at which bank rediscounts the
approved bills held by commercial banks. For controlling the credit, inflation and money supply,
bank will increase the Bank Rate.
2. Open Market Operations: These refer to direct sales and purchase of securities and bills in the
open market. The aim is to control volume of credit.
3. Varying Interest Rates: Commercial banks vary interest rates depending on the credit
requirements of the society.
4. Varying Reserve Requirements: The central bank changes the rate of cash reserve and it has
direct effect on money supply. Cash Reserve Ratio (CRR) refers to that portion of total deposits
in commercial Bank which it has to keep with RBI as cash reserves. An increase in CRR will
decrease the capacity of banks to lend money thereby decrease the money supply and vice versa.
Statutory Liquidity Ratio (SLR) refers to that portion of deposits with the banks which it has to
keep with itself as liquid assets (Gold, approved govt. securities etc.) If bank wishes to control
credit and discourage credit it would increase CRR & SLR.
5. Varying Repo Rate and Reverse -Repo rate: Repo rate is the rate at which the central bank of a
country lends money to commercial banks in the event of any shortfall of funds. Repo rate is used
by monetary authorities to control inflation. Reverse repo rate is the rate at which the central bank
of a country borrows money from commercial banks within the country. It is a monetary policy
instrument which can be used to control the money supply in the country.

Qualitative or Selective Method of Credit Control: The qualitative or the selective

methods are directed towards the diversion of credit into particular uses or channels in the economy.
Their objective is mainly to control and regulate the flow of credit into particular industries or businesses.
The following are the important methods of credit control under selective method:

1. Rationing of Credit: Under this method the credit is rationed by limiting the amount available
to each applicant. The Central Bank puts restrictions on demands for accommodations made upon
it during times of monetary stringency. In this the Central Bank discourages the granting of loans
to stock exchanges by refusing to re-discount the papers of the bank which have extended liberal

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 loans to the speculators. This is an important method of credit control and this policy has been
adopted by a number of countries like Russia and Germany.

2. Direct Action: Under this method if the Commercial Banks do not follow the policy of the
Central Bank, then the Central Bank has the only recourse to direct action. This method can be
used to enforce both quantitatively and qualitatively credit controls by the Central Banks. This
method is not used in isolation; it is used as a supplement to other methods of credit control.
Direct action may take the form either of a refusal on the part of the Central Bank to re-discount
for banks whose credit policy is regarded as being inconsistent with the maintenance of sound
credit conditions. Even then the Commercial Banks do not fall in line, the Central Bank has the
constitutional power to order for their closure. This method can be successful only when the
Central Bank is powerful enough and has cordial relations with the Commercial Banks. Mostly
such circumstances are rare when the Central Bank is forced to resist to such measures.

3. Moral Suasion: This method is frequently adopted by the Central Bank to exercise control over
the Commercial Banks. Under this method Central Bank gives advice, then request and
persuasion to the Commercial Banks to co-operate with the Central Bank is implementing its
credit policies. If the Commercial Banks do not follow or do not abide by the advice or request of
the Central Bank no gross action is taken against them. The Central Bank merely was its moral
influence and pressure with the Commercial Banks to prevail upon them to accept and follow the
policies.

4. Method of Publicity: In modern times, Central Bank in order to make their policies successful,
take the course of the medium of publicity. A policy can be effectively successful only when an
effective public opinion is created in its favour. Its officials through news-papers, journals,
conferences and seminar’s present a correct picture of the economic conditions of the country
before the public and give a prospective economic policies. In developed countries Commercial
Banks automatically change their credit creation policy. But in developing countries Commercial
Banks being lured by regional gains. Even the Reserve Bank of India follows this policy.

5. Regulation of Consumer’s Credit: Under this method consumers are given credit in a little
quantity and this period is fixed for 18 months; consequently credit creation expanded within the
limit. This method was originally adopted by the U.S.A. as a protective and defensive measure,
there after it has been used and adopted by various other countries.

6. Changes in the Marginal Requirements on Security Loans: This system is mostly

followed in U.S.A. Under this system, the Board of Governors of the Federal Reserve System has
been given the power to prescribe margin requirements for the purpose of preventing an excessive
use of credit for stock exchange speculation.

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Objectives of credit control: Credit control policy is just an arm of economic policy,
hence, its main objective being the attainment of high growth rate while maintaining the
reasonable stability of the internal purchasing power of money. The broad objectives of credit
control policy in have been- Ensure an adequate level of liquidity enough to attain high economic
growth rate along with maximum utilisation of resource but without generating high inflationary
pressure. Attain stability in the exchange rate and money market of the country. Meeting the
financial requirement during a slump in the economy and in the normal times as well. Control
business cycle and meet business needs.