Question

Q#04: Explain how central bank is functioning and what is its role in development of financial structure?

Answer 1

Central Bank

A Central Bank is an independent authority of the nation that is responsible for driving monetary policy, regulating commercial banks and non-banking finance institutions and also providing financial services involving economic research and periodic data.

It serves as the leader of the banking system of the nation and its money market. It regulates money supply and credit in the country. While doing so, it has to ensure that it remain free from political influence in its day-to-day operations.

Its basic goal is to stabilize the nation's currency, keep inflation under check.

Central Bank offers a range of tools and information to assist financial institutions in meeting reporting requirements and understanding policies governing reserve requirements, term deposits and lending and other functions.

A central bank is a lender of last resort to troubled financial institutions and even governments.

Role of Central Bank in developing Financial Structure:

The Central Bank aims at the promotion and maintenance of a rising level of production, employment and real income in the country. The central bank generally enjoys wide powers to promote the growth of economy.

Financial supervision:

The primary objective of Central Bank is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions, and non-banking finance institutions.

More Commercial banks and financial institutions are required to be set up to provide larger credit facilities and to divert voluntary savings into productive channels.

Regulator and supervisor of the financial system

The Central Bank has the responsibility of regulating the nation's financial system. As a regulator and supervisor of the banking system it ensures financial stability & public confidence in the banking system. It uses methods like On-site inspections, off-site surveillance, scrutiny & periodic meetings to supervise new bank licences, setting capital requirements and regulating interest rates in specific areas.

Issue of currency

The Central Bank is the sole body authorised to issue banknotes.

The bank also destroys banknotes when they are not fit for circulation. All the money issued by the central bank is its monetary liability, i.e., the central bank is obliged to back the currency with assets of equal value, to enhance public confidence in paper currency. The objectives are to issue banknotes and give the public adequate supply of the same, to maintain the currency and credit system of the country to utilise it in its best advantage, and to maintain the reserves.

The Central Bank maintains the economic structure of the country so that it can achieve the objective of price stability as well as economic development because both objectives are diverse in themselves.

Debt Management:

Debt management is one of the important functions of the central bank. It should aim at proper timing and issuing of government bonds, stabilizing their prices and minimizing the cost of servicing public debt. It is the central bank which undertakes the selling and buying of government bonds and making timely changes in the structure and composition of public debt.

Maintaining Interest Rates:

The Central Bank also performs the viatal task of maintaining the Interest Rates. It regulates the interest rates on the credit flow by either increasing or reducing the same. In order to increase flow of money into the economy, it reduces the rates and vice versa.

The bank is having closer look at the economy at all the time hence, the interest rates are revised periodically to balance the economic activities.

Proper Adjustment between Demand for and Supply of Money:

The Central Bank plays an important role in making proper adjustment between demand for and supply of money. An imbalance between the two is reflected in the price level. A shortage of money supply will inhibit growth while an excess of it will lead to inflation. As the economy develops, the demand for money is likely to go up due to gradual monetization of the non-monetized sector and the increase in agricultural and industrial production and prices.

The central bank controls the uses of money and credit by an appropriate monetary policy.

Custodian to foreign exchange

The Central Bank has custody of the country's reserves of international currency, and this enables the Bank to deal with crisis connected with adverse balance of payments position.

Thus the Central Bank plays an important role in achieving economic growth of the country through the various measures discussed above. It promotes economic growth with stability, helps in attaining full employment of resources, in overcoming balance of payments disequilibrium, and in stabilising exchange rates.