Chapter 4

Role and Function of Central Bank

Course: Fin-209
Law & Practice of Banking
 Role and Function of Central Bank  The ministry of Finance (MoF) issues 1 to 5 taka notes and
coins and BB on it’s behalf distributes all over the country
as agent of the Government.
1. Traditional Central Banking Functions (Monetary
Functions)
Banker to Government
a) Bank of Issue – The Minimum Reserve System.
Central Bank acts as a government banker, agent and adviser.
b) Banker to Government.
 Bangladesh Bank is an agent of Government of
c) Banker's Bank and Lender of the Last Resort.
Bangladesh.
d) Controller of Credited.
 Central Bank has the obligation to transact government
e) Custodian of Foreign Reserves.
business, to keep the cash balances as deposits free of
2. Supervisory Functions
interest, to receive and to make payments on behalf of the
3. Promotional Functions
government.
4. Miscellaneous Functions
 Carry out government exchange remittances and other
a) Interest Rate Intervention.
banking operations.
b) Monetary Policy Instruments.
 Bangladesh Bank helps the government — both the Union
and the states to float new loans and to manage public
Traditional Central Banking Functions (Monetary debt.
Functions)  It makes Ways and Means Advances (WMA) to the
Bank of Issue — The Minimum Reserve System governments for 90 days.
 Central Bank has a separate Issue Department,  It makes loans and advances to the government
which is entrusted with the issue of currency notes. authorities.
The assets and liabilities of the Issue Department  It acts as adviser to the government on all monetary and
are kept separate from those of the banking banking matters.
department.
 The Bank has the sole right to issue banknotes of all
denominations except below TK. 10 note.
Banker’s Bank and Lender of the Last Resort
Bangladesh Bank acts as the banker’s bank:
1. CRR: CRR stands for Cash Reserve Ratio and specifies
in percentage the money commercial banks need to
keep within themselves in the form of cash. In reality,
banks deposit this money with them, The ratio is
calculated by Bangladesh Bank.
When Bangladesh Bank lowers CRR, it allows banks to
have surplus money that they can lend to invest
anywhere they want. A higher CRR means banks have a
lesser amount of money at their disposal to distribute.
This serves as a measure to controls inflationary forces
in the economy. The present rate of CRR is 6%.
2. SLR: It stands for Statutory Liquidity Ratio and it’s
prescribed by Bangladesh Bank as a ratio of cash
deposit that banks have to maintain in form of gold,
cash and other securities approved by Bangladesh
Bank.
This is done by Bangladesh Bank to regulate the growth
of credit. The present SLR is 13%. Bangladesh Bank has
the power to increase it If it deems fit in the interest of
the economy.
3. The scheduled banks can borrow from Bangladesh
Bank on the basis of eligible securities.
4. Commercial banks can always expect from Bangladesh Bank
to come to their help in times of banking crisis. Bangladesh
Bank becomes the lender of the last resort.
5. Can get financial accommodation in times of need or
strictness by rediscounting bills of exchange.
Controller of Credit
Bangladesh Bank is the controller of credit and it’s features are:
• Through open market operations, a central bank influences
the money supply in an economy directly.
• Since 1956, selective controls of credit are increasingly
being used by Bangladesh Bank.
• Every bank has to get a license from the Bangladesh Bank
to do banking business within the country.
• The license can be cancelled by Bangladesh Bank if certain
stipulated conditions are not fulfilled. Every bank will have
to get the permission before it can open a new branch.
• Each scheduled bank must send a weekly report to
Bangladesh Bank showing, in detail, it’s assets and
liabilities.
• Bangladesh Bank has also the power to inspect the
accounts of any commercial bank.
• These powers of the bank, to call for information, are also
intended to give it effective control of the credit system.
Custodian of Foreign Reserves
Bangladesh Bank has the responsibility to maintain the
official rate of exchange.
• According to Bangladesh Bank Act of 1972, banks
are required to buy and sell foreign currency at
floating rate. Bangladesh maintains a floating
exchange rate of it’s currency but practices what is
called managed floating or pegged floating regime,
also known as dirty floating. What we are doing is
pegging our currency it’s intervention currency to
the US Dollar, almost always at an overvalued level.
• After Bangladesh became a member of the
International Monetary Fund in 1972, it has the
responsibility of maintaining fixed exchange rates
with other member countries of IMF.
• Bangladesh Bank has to act as the custodian of
Bangladesh’s reserve of international currencies.
• Bangladesh Bank has the responsibility of
administering the exchange controls of the country.
Bangladesh Bank has the following powers:
 It holds the cash reserves of all the scheduled
banks.
 It controls the credit operations of banks through
quantitative and qualitative controls.
 It controls the banking system through the system of
licensing, inspection and calling for information.
 It acts as the lender of the last resort by providing
rediscounting facilities to scheduled banks.
 Controller of Forex Reserves of the country.
 In addition to it’s traditional central banking functions,
Bangladesh Bank has certain on-monetary functions of the
nature of supervision of banks and promotion of sound
banking in Bangladesh.
Supervisory Functions (Non-monetary Functions)
 The Bangladesh Bank Order (1972) has given Bangladesh
Bank wide powers.
 Bangladesh Bank has to supervise and control commercial
and co-operative banks in relation to licensing and
establishments, branch expansion, liquidity of their assets,
management and methods of working, amalgamation,
reconstruction and liquidation.
 Bangladesh Bank is authorized to carry out periodical
inspections of the banks and to call for returns and
necessary information from them.
 Bangladesh Bank directs the growth of banking and credit
policies towards more rapid development of the economy.
 Bangladesh Bank have helped a great deal in improving
the standard of banking in Bangladesh.
Promotional Functions (Non-monetary
Functions)
1. Central Bank promotes the banking habit.
2. Extends banking facilities to rural and semi-urban
areas.
3. Establishes and promotes new specialized financing
agencies.
4. Development of the co-operative credit movement
to encourage savings and to eliminate
moneylenders from the villages and to route it’s
short-term credit to agriculture.
Monetary Policy Instruments
The main monetary policy instruments available to central
banks are open market operation, bank reserve requirement,
interest-rate policy, re-lending and rediscount (including
using the term repurchase market) and credit policy.
Techniques of Credit Control
1. Quantitative or General Methods
• Bank Rate Policy: The standard rate at which
the central bank is ready to buy or rediscount
commercial papers eligible for purchase. At
present the bank rate is 4%.
• Open Market Operations: Enforcing monetary
policy by which BB controls the short term rate of
interest and the supply of base money in an
economy, and thus indirectly the total supply of
money. During inflation, BB sells securities to finish
off the excess money in the market. Similarly, to
increase the money supply, BB purchases securities.
• Adjusting with CRR and SLR: By adjusting the CRR
(Cash Reserve Ratio) and SLR (Statutory Liquidity
Ratio) which are short term tools to be used to
shortly govern the cash and fund flows in the hands
of the banks, people and government, the central
bank regularly make necessary alterations in these
rates. These variations in the rates will easily have a
larger control over the cash flow of the country.
• Lending Rate: Lending rates can be defined as the
ratios fixed by BB to lend the money to the
customers on the basis of those rates. The higher the
rate of lending signifies the costlier credit to the
customers. The lower the rate of lending will
encourage the customers to borrow funds from the
banks more that will facilitate the flow of more
money in the hands of public.
 • Repo Rate: The rate at which banks borrow
funds from the central bank to fill the gap
between the demand they are facing for
providing loans to their customers and how
much funds they have on hand to lend.
• Reverse Repo Rate: The rate at which Central
Bank borrows money from the banks or banks
lend money to Bangladesh Bank. Bangladesh
Bank uses this instrument when it feels there
is too much funds floating in the banking
industry.
2. Qualitative or Selective Methods:
• Marginal Requirements: Every commercial
bank has to keep a margin whenever it
provides loans against the security. It means
that the amount of loan is lower than the real
value of security.
• Regulation of Consumer Credit: The act of
selling a consumer good on a credit basis to
the customers. Central bank can cut the
money supply by putting limitations on
consumer credit.
• Credit Rationing: Central bank uses credit rationing to fix
the credit ceiling allowed for each and every commercial
bank.
• Moral Suasion: Central bank morally persuades
commercial banks not to get involved in economic
activities which are unfavorable to the interest of the
country. It regularly guides and proposes the member
banks to follow a specific policy for loans.
• Direct Action: The last option through which central bank
takes a direct-action against the bank which does not act
in conformity with the policy of BB. The central bank can
impose fine and penalty and can deny giving out loans to
the commercial bank.
• Publicity: Central bank publishes details concerning it’s
policies and important information about assets and
liabilities, credit and business situation etc. of commercial
banks. This facilitates commercial banks as well as general
public to realize the monetary needs of country. Central
bank discloses some of the important information about
the commercial banks so that the people know about the
several activities of commercial banks and can protect
themselves from any potential loss in the future.