CENTRAL BANKING

III SEMESTER MA ECONMICS

September 2021

BIJU ABRAHAM
NMSM GOVERNMENT COLLEGE KALPETTA
 INTRODUCTION

Banking has a history extent to be as old as the history of mankind

From a non-institutionalisd form, it transformed to an

institutionalized system.

Thus, bank is understood as an Eg. Depositing/ lending of money,

institution that offers various foreign exchange, safe keeping, various
financial services etc.
financial services
 
 
 A BRIEF HISTORY

•  As early as 2000 BC, Babylonians has developed a system of

bank.

• In ancient Greece and Rome , the practice of granting credit

was widely prevalent.

• Traces of credit by compensation and by transfer order were

prevalent in Assyria, Phoenicia and Egypt.

• In Italy, especially cities like  Florence, Venice and Genoa saw the

development of modern banking
 BANKING IN INDIA
• Vedic times literature refers to existence of money lending operations

• Extensive reference in the laws of Manu on money lending.

• Rate of interest at around 15%.

• Differential rate of interests were charged basis caste

• (Brahmin:2%;Kshatriya:3%,Vaish:4% and Shudra:5% PER MONTH)
 BANKING IN INDIA
• Chanakya however devised the interest rate structure which was risk
weighed.
• 15% p.a for general advances.
• 60% p.a for trading .
• 240% p.a for export import business •

• Money lending business could be taken only by Vaishyas according to

Dharmashastras.
 CENTRAL BANK: A BRIEF HISTORY

• A central bank is the term used to describe the authority responsible for policies that
affect a country’s supply of money and credit. 
• It had a very gradual evolution and the first central bank is said to have originated in
Venice
• In 1282, the state owned Grain Office, ( responsible to buy grains from importers
and resell to the population) was given responsibility to issue floating debt and also
to collect deposit from public
• It became the first state owned bank
• The securities issued by the bank become acceptable among the traders and thus,
 CENTRAL BANKING HISTORY: CONTINUE

• The grain office failed due to the financial liability

• In 1587, Banco della Piazza di Rialto, a public sector bank was
established
• To finance military expences, bank was forced to issue inconvertable
money and later it was used to pay for the bill of exchange
• The bank was Banco della Piazza di Rialto was closed in 1638 and later
The Banco del Giro was established as the central bank which continue
its functions till its was liquidated by Nepolian.
 HISTORY OF CENTRAL BANK
• the first institution recognized as a central bank, the Swedish Riksbank was
established in 1668 as a joint stock bank,
• It was chartered to lend the government funds and to act as a clearing house for
commerce
• In 1694 , the most famous central bank of the era, the Bank of England, was
founded also as a joint stock company to purchase government debt.
• Other central banks were set up later in Europe for similar purposes, though some
were established to deal with monetary disarray.
• For example, the Banque de France was established by Napoleon in 1800 to stabilize
the currency after the hyperinflation of paper money during the French Revolution,
as well as to aid in government finance.
• Early central banks issued private notes which served as currency, and they often
had a monopoly over such note issue.
 DEFINITION OF A CENTRAL BANK
• A central bank is a financial institution given privileged control over the production
and distribution of money and credit for a nation or a group of nations

• Samuelson, “Every Central Bank has one function. It operates to control

economy, supply of money and credit.”

• 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.”

• “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.
 FEATURES OF CENTRAL BANK
• Legal entity
• Monopoly power
• Non- market institution
• anti-competitive institution
 NEED FOR CENTRAL BANK
• Two main factors

• 1. Financial stability

• 2. Monetary stability
 FINANCIAL STABILITY
• Management of the Payment system

• To provide security and support related to the instability ( risk)

associated with banking
 MONETARY STABILITY
• To ensure continuity of the banking activity irrespective of the government in action.

• The stabilization function of the monetary sector in an economy

 FUNCTIONS OF CENTRAL BANK
• Regulator of Currency
• Controller of Credit:
• Banker, Fiscal Agent and Adviser to the Government:
• Custodian of Cash Reserves of Commercial Banks:
• Custody and Management of Foreign Exchange
Reserves:
• Lender of the Last Resort:
• Clearing House for Transfer and Settlement:
• Collection, maintenance and dissemination of
information
FEDERAL RESEARVE SYSTEM
 A BRIEF HISTORY
• Under colonial rule, Americans used European coins, commodity money, and
barter as their primary means of exchange
• With increasing difficulty associated with foreign exchange and barter
system, colonies began to issue paper currency and mint coins
• Bank’s functions were limited to issue paper currency based on the security received
( land, gold etc) – no accepting deposits, giving loans etc were undertaken
• To finance American Revolution, the Continental Congress printed the new nation's first
paper money "continentals" .
• The huge quantity printed caused inflation and people lost faith in it and the phrase
“not a worth a continental” emerged
• After ratification of the constitution, Treasury Secretary
Alexander Hamilton, took initiative to establish a central bank.
• The aim of the bank was, issue a unified currency to the
nation, act as government bank, to finance government
activities and to give credit to business
• This was looked by suspicion by the people lead by the then
Secretary of State Thomas Jefferson
• With approval of the Congress, The First Bank of the United
States, headquartered in Philadelphia, was established in
1791
• After 20 years, the bill to re-charter the bank was defeated
• The country returned back to the same colonial situation with no central
banking system to control the monetary sector
 SECOND BANK OF THE UNITED STATES

• To overcome the financial crisis , in 1816, the Second Bank of

the United States was chartered

• It lasted till 1836, when President Andrew Jackson

declared it unconstitutional 
 FREE BANKING ERA
• Next 25 years is known as free banking era

• An era of  state-chartered banks operating without any federal regulation.

• By 1860, there were nearly 8,000 state banks, each issuing its own paper notes
• There were also  “wildcat banks,” which maintained its office in very remote areas
where customers cannot reach easily.
 NATIONAL BANKING ACT
• During the Civil War, the National Banking Act of 1863 was passed,
• providing for nationally chartered banks,
• Only nationally charted banks can issue notes which are backed by US
government securities.
• The National Banking Act failed to bring a strong economic base
• The financial panic emerged
• 1907 was an year of worst financial panic in the US
• Call for reforms was from every corner of the country
• The Aldrich-Vreeland Act of 1908, was passed
• Monetary Commission to search for a long-term solution
• The Aldrich-Vreeland Act of 1908 was abandoned in 1912 when Woodrow
Wilson came to power
 FEDERAL RESERVE ACT 1913

• December 23, 1913, President Woodrow Wilson signed the Federal Reserve Act

• THE FEDERAL RESEARVE SYSTEM came into existence

• It is a decentralized central bank that balanced the competing interests of private

banks and populist sentiment.
• The Federal Reserve system consists of 12 Federal Reserve Banks

• The Board of Governors, located in Washington, D.C., provides the leadership

for the System.
Structure of the Federal Reserve
• The Federal Reserve System has a two-part structure:
• a central authority called the Board of Governors located in
Washington, D.C.,
• a decentralized network of 12 Federal Reserve Banks located
throughout the U.S.
Structure of Federal Researve
 The Board Of Governers
• Located at Washington DC
•  Board is charged with overseeing the entire Federal Reserve System and operates as an
independent government agency.
• made up of seven members who are nominated by the President and confirmed by the
Senate.
• Members serve staggered 14-year terms that expire in even-numbered years.
• . From these members, the President also designates a Chair and two Vice Chairs of the
Board to serve four-year terms.
 Regional Reserve Bank
• The Fed includes 12 regional Federal Reserve Banks that carry out
much of the System’s day-to-day operations.
• known as district banks
• Work as a not-for profit organization
• Branches of the Reserve Banks are located in 24 other cities.
• Reserve Bank has a president and board of directors
• Each Reserve Bank and each of their branches has a board of directors.
• The directors are representative of people from all walks of life
 The Federal Open Market Committee (FOMC)
• the Fed’s monetary policy-making body
• The FOMC has 12 voting members, including all seven members of the
Board of Governors and a rotating group of five Reserve Bank presidents. 
• The Chair of the Board of Governors also serves as Chair of the FOMC.
• The president of the Federal Reserve Bank of New York serves as Vice Chair of the
FOMC.
• The NY Fed is directly involved in carrying out monetary policy operations, so its
president has a permanent vote on the FOMC
• All 12 Reserve Bank presidents participate in FOMC meetings
• The FOMC holds eight regularly scheduled meetings a year in Washington, D.C.
• On the last day of the meeting, monetary policy actions are put to vote
• “Statement on Longer-Run Goals and Monetary Policy Strategy.”
• This document outlines how Fed policymakers interpret the Fed’s dual mandate
from Congress to promote full employment and stable prices.
• “Summary of Economic Projections.”-- FOMC provide their views on the likely
direction of future monetary policy in a document
• The Committee releases these projections four times each year.
 Other significant institutions
• (a) Depository Institutions (b) Advisory Councils
(A)Depository Institutions
banks, thrifts, and credit unions
• Depository institutions offer transaction, or checking, accounts to the public, and
may maintain accounts of their own at their local Federal Reserve Banks.
• Depository institutions are required to meet reserve requirements--that is, to keep
a certain amount of cash on hand or in an account at a Reserve Bank based on
the total balances in the checking accounts they hold.
• (A) Federal Advisory Council (FAC). This council, established by the Federal
Reserve Act, comprises 12 representatives of the banking industry. 
• (B) Community Depository Institutions Advisory Council (CDIAC). The
CDIAC was originally established by the Board of Governors to obtain information
and views from thrift institutions (savings and loan institutions and mutual savings
banks) and credit unions.
• (C) Model Validation Council. This council was established by the Board of
Governors in 2012 to provide expert and independent advice on its process to
rigorously assess the models used in stress tests of banking institutions.
• (D) Community Advisory Council (CAC). This council was formed by the
Federal Reserve Board in 2015 to offer diverse perspectives on the economic
circumstances and financial services needs of consumers and communities, with
a particular focus on the concerns of low- and moderate-income populations. 
Functions
• Conducting the nation's monetary policy by influencing money
and credit conditions in the economy in pursuit of full
employment and stable prices.
• Supervising and regulating banks and other important financial
institutions to ensure the safety and soundness of the nation's
banking and financial system and to protect the credit rights of
consumers.
• Maintaining the stability of the financial system and containing
systemic risk that may arise in financial markets.
• Providing certain financial services to the U.S. government, U.S.
financial institutions, and foreign official institutions, and playing
a major role in operating and overseeing the nation's payments
systems.