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Central banking
what is central banking system?
Before the world war first there was only a few countries which had
their own central banks. After the war, the number of central banks
has increased and now there is no single country in the world which
does not have its own central bank.
Assets structure:
the assets structures of the central bank differ from country to
country. In some countries, the central banks are nationalized. e.g
Bank of France (1800), Reserve Bank of India (1947) are nationalized.
They are owned and operated by their governments. The Federal
Reserve system of America (1914) and Netherlands (1814) are
private banks. The bank of Japan and State bank of Pakistan (1948) had
mixed ownership. The Government owned 51% of the share capital of
SBP and 49% was held by the public. Now it is fully state owned after
the nationalization of banks in 1974.
Organization: the organization of the central banks are also not the
same. For example, the organization of Federal reserve system
comprises five agencies or group of agencies:
1.
The Board of Governors
ii.
iii.
iv.
v.
The Federal Open Market Committee
The Federal Advisory Council
The Federal Reserve Banks and their branches
Member Banks of Federal Reserve System.
FUNCTIONS OF A CENTRAL BANK
The important functions of a central bank are as follows.
1.
Sole right of note issue.
the printing and issue of currency notes is one of the important
functions of central bank. The right of note issue is regulated by law,
the requirements of the business and in the best interest of the
country. It brings uniformity in the system of note issue. It exercises
better control over the money supply in the country. It enables central
bank to control the lending operations of the commercial bank.
2.
Banker’s Agent and Adviser to the government.
the central bank acts as banker agent and adviser to the government.
a.
As Banker to the government, it receives deposits, cheques and drafts
deposited in the government account.
b.
It makes short term advances to the government.
iii.
iv.
v.
3.
i.
ii.
4.
It provides foreign exchange to government for the purchase of
foreign goods, repaying external debts etc.
As financial agent,
it collects taxes and other payments
on behalf of the government. It also manages exchange stabilization
funds.
As Adviser:
to the government, it gives advice on all
monetary and financial matters such as deficit financing, foreign
exchange policy etc.
Banker to commercial banks.
As banker to commercial
banks, the central bank performs the following functions.
It hold cash reserves and deposits of commercial banks.
it rediscounts the bills of exchange of commercial banks to cover
temporary difficulties.
Clearing Agent. As the custodian of the cash reserves of
commercial banks, the central bank acts as a clearing house for
commercial banks. As all schedule banks have their accounts with
the central bank against each other with least use of cash.
5. Controller of credit.
The central bank is entrusted to regulate the volume of
credit and currency in the country. In order to achieve
this objective, it uses various policy tools such as
required reserve ratios, discount rate, open market
operations etc.
6. Lender of the last resort:
The central bank is the supreme bank of the country. If
the commercial banks are at any time in need of money
and are not able to meet their financial requirements
from any other source, they can approach the central
bank for financial accommodation. The central bank as
lender of last resort provides financial help to the
commercial bank by rediscounting their bills of
exchange.
7.
.
Custodian of foreign exchange reserves
v.
The central bank acts as custodian of foreign exchange reserves. As
custodian,
It helps the central bank to correct adverse balance of payments,
Check flight of capital from the country,
Stabilize exchange rate,
Paying off external debts,
The exchange rate determination etc.
8.
Development role:
i.
ii.
iii.
iv.
In the developing countries of the world,
the central bank besides performing the traditional functions also
performs developmental and promotional functions. The central bank
undertakes the responsibility of economic growth with stability in the
economy. It ensures that the funds available flow to the various priority
sectors such as agricultures, expert sector, small scale sector etc.
9. Other functions.
a.
b.
c.
it maintains relations with international agencies such as IMF, word bank
etc.
It provided training facilities to the staff working in various banking
institutions.
It conducts seminars, surveys and publishes annual reports giving real
economic picture of the economy.
Monetary Policy
What is monetary policy?
According to Professor Spencer. “Monetary policy is the deliberate exercise of
the monetary authority’s power to induce expansion or contraction in the
money supply”
According to G.K Shaw, by monetary policy is meant “any action undertaken by
the monetary authorities to change the quantity, availability and interest
rate of money”.
Objectives of Monetary policy:
1.
Promoting higher employment
2.
Steady economic growth
3.
Stable price level
4.
Interest rate stability
5.
Stability of financial market
6.
Stability in foreign exchange markets.
Tools of monetary policy
Instruments of monetary policy:
(a)
1.
2.
3.
4.
(a)
1.
The main tools or weapons available to the central bank for influencing the
level of economic activity in a country are as follows:
Quantitative Controls. (b)
Qualitative Controls
Open Market Operations. 1.
varying Marginal Requirements.
Variation in the bank Rate. 2.
consumer’s Credit Regulation.
Credit Rationing
3.
Use of Moral Persuasion.
Varying Reserve
4.
Direct Action.
Requirements
Quantitative Instruments.
Open Market Operations.
When ever there is inflation in the
country the central bank issues the bond and securities and sale it in the
market to reduce the consumption in the country. And vice versa. The
open market purchase of government securities by the central bank of the
country are expansionary and the sale of government securities are
contraction policy.
2.
3.
Changing the discount rate.
The central bank give loans to
commercial bank on rediscounting bills of exchange or on other securities
so to reduce the money supply in the country the central bank increase the
bank rate or the interest rate charged by the central bank to the
commercial bank on loans. In this way the central bank discourage loan
during inflation in the country. In case of deflation the case is other wise.
Changing the legal reserve requirement:A central bank can affect
the supply of money and the availability of bank credit in a country by
changing the legal reserve requirement of the commercial banks. If there is a
recession in the country, the central bank decreases the required reserve
ratio of the economy, the central bank decreases the required reserve ratio
of the member banks. It permits banks to lend more money and thereby
enlarge the money supply. In case the economy is inflationary, the central
bank can increase the reserve requirements of the banks. The lending
power of the banks is reduced which ultimately results in decrease of the
money supply.
4.
Credit rationing.
This method of credit control is applied by
the central bank in time of financial crisis. The central bank rations the
credit of each member bank. It fixes the maximum amount which each
member bank can draw by rediscounting bills of exchange.