In the banking system, the central bank is recognized as the most

powerful financial institution. It is considered to be an important part

of a country's economic and financial structure. The central bank is
an independent authority in charge of supervising, regulating, and
stabilizing the country's monetary and banking framework. The
Reserve Bank of India is the country's central bank. It was founded
in 1935. Central banks are in charge of ensuring the country's
Financial Stability and Economic sovereignty.

The meaning of central bank is a financial institution that has the

privilege of producing and distributing money (and credit) for a
country or a group of countries. The central bank, in the modern
economy, is also responsible for regulating member banks and
formulating monetary policies. This article will acquaint you with the
importance of the central bank with a focus on the functions of the
central bank of India.

Features of Central Bank

The basic nature of Central banks is that they are non-market-based
and also anti-competitive institutions. The key features of a central
bank are:
 Most central banks are centralized though there could be
central banks that are not government agencies.
 Even if the central government does not own a central bank,
the law establishes and protects the privileges of a central
bank.
 It has a legal monopoly status that enables it to issue cash and
banknotes as opposed to private commercial banks that can
issue only demand liabilities, for example, checking deposits.

Functions of Central Bank

A central bank is deemed as the lender of the last resort, as per
Hawtrey ( a British economist). The central bank is the organ of the
government which controls major financial operations of the
government. Through its various operations, the objectives of the
central bank are to support the economic policy of a country by
influencing the way financial institutions behave.

The central bank of India is RBI or Reserve bank of India and it is a

statutory bank. The primary role of RBI in India is to print currency
notes and manage the money supply in the economy of India. Let us
now delve into the central bank and its functions where we will
discuss the role of the central bank in the money market:
Central Bank And Their Functions

1. The central bank is the apex institution of a country’s monetary

system. The design and the control of the country’s monetary policy is its
main responsibility. India’s central bank is the Reserve Bank of India.
2. Functions of Central Bank.
(a) Currency Authority:
(i) The central bank has the sole monopoly to issue currency notes.
Commercial banks cannot issue currency notes. Currency notes issued by
the central bank are the legal tender money.
(ii) Legal tender money is one, which every individual is bound to accept
by law in exchange for goods and services and in the discharge of debts.
(iii) Central bank has an issue department, which is solely responsible for
the issue of notes.
(iv) However, the monopoly of central bank to issue the currency notes
may be partial in certain countries.
(v) For example, in India, one rupee notes and all types of coins are issued
by the government and all other notes are issued by the Reserve Bank of
India.
(b) Banker, Agent and Advisor to the Government: Central bank
everywhere in the world acts as banker, fiscal agent and adviser to their
respective government.
(i) As Banker: As a banker to the government, the central bank performs
same functions as performed by the commercial banks to their customers.
• It receives deposits from the government and collects cheques and
drafts deposited in the government account.
• It provides cash to the government as resumed for payment of salaries
and wages to their staff and other cash disbursements.
• It makes payments on behalf of the government.
• It also advances short term loans to the government.
• It supplies foreign exchange to the government for repaying external
debt or making other payments.
(ii) As Fiscal Agent: As a fiscal agent, it performs the following functions :
• It manages the public debt.
• It collects taxes and other payments on behalf of the government.
• It represents the government in the international financial institutions
(such as World Bank, International Monetary Fund, etc.) and conferences.
(iii) As Adviser
• The central bank also acts as the financial adviser to the government.
• It gives advice to the government on all financial and economic matters
such as deficit financing, devaluation of currency, trade policy, foreign
exchange policy, etc.
3. Banker’s Bank and Supervisor:
(a) Banker’s Bank: Central bank acts as the banker to the banks in three
ways: (i) custodian of the cash reserves of the commercial banks; (ii) as
the lender of the last resort; and (iii) as clearing agent.
(i) As a custodian of the cash reserves of the commercial banks, the
central bank maintains the cash reserves of the commercial banks. Every
commercial bank has to keep a certain percent of its cash reserves with
the central bank by law.
(ii) As Lender of the Last Resort.
• As banker to the banks, the central bank acts as the lender of the last
resort.
• In other words, in case the commercial banks fail to meet their financial
requirements from other sources, they can, as a last resort, approach to
the central bank for loans and advances.
• The central bank assists such banks through discounting of approved
securities and bills of exchange.
(ii) As Clearing Agent
• Since it is the custodian of the cash reserves of the commercial banks,
the central bank can act as the clearinghouse for these banks.
• Since all banks have their accounts with the central bank, the central
bank can easily settle the claims of various banks against each other
simply by book entries of transfers from and to their accounts.
• This method of settling accounts is called Clearing House Function of the
central bank.
(b) Supervisor
(i) The Central Bank supervises, regulate and control the commercial
banks.
(ii) The regulation of banks may be related to their licensing, branch
expansion, liquidity of assets, management, amalgamation (merging of
banks) and liquidation (the winding of banks).
(iii) The control is exercised by periodic inspection of banks and the
returns filed by them.
4. Controller of Money Supply and Credit: Principal instruments of
Monetary Policy or credit control of the Central Bank of a country are
broadly classified as:
(a) Quantitative Instruments or General Tools; and
(b) Qualitative Instruments or Selective Tools.
(a) Quantitative Instruments or General Tools of Monetary Policy: These
are the instruments of monetary policy that affect overall supply of
money/credit in the economy. These instruments do not direct or restrict
the flow of credit to some specific sectors of the economy. They are as
under:
(i) Bank Rate (Discount Rate)
• Bank rate is the rate of interest at which central bank lends to
commercial banks without any collateral (security for purpose of loan).
The thing, which has to be remembered, is that central bank lends to
commercial banks and not to general public. It tackles “””??????>:[[].’pp.[
• In a situation of excess demand leading to inflation,
-> Central bank raises bank rate that discourages commercial banks in
borrowing from central bank as it will increase the cost of borrowing of
commercial bank.
-> It forces the commercial banks to increase their lending rates, which
discourages borrowers from taking loans, which discourages investment.
-> Again high rate of interest induces households to increase their savings
by restricting expenditure on consumption.
-> Thus, expenditure on investment and consumption is reduced, which
will control the excess demand.
• In a situation of deficient demand leading to deflation,
-> Central bank decreases bank rate that encourages commercial banks
in borrowing from central bank as it will decrease the cost of borrowing of
commercial bank.
-> Decrease in bank rate makes commercial bank to decrease their
lending rates, which encourages borrowers from taking loans, which
encourages investment.
-> Again low rate of interest induces households to decrease their savings
by increasing expenditure on consumption.
-> Thus, expenditure on investment and consumption increase, which will
control the deficient demand.
(ii) Repo Rate
• Repo rate is the rate at which commercial bank borrow money from the
central
bank for short period by selling their financial securities to the central
bank.
• These securities are pledged as a security for the loans.
• It is called Repurchase rate as this involves commercial bank selling
securities
to RBI to borrow the money with an agreement to repurchase them at a
later
date and at a predetermined price.
• So, keeping securities and borrowing is repo rate.
• In a situation of excess demand leading to inflation,
-> Central bank raises repo rate that discourages commercial banks in
borrowing from central bank as it will increase the cost of borrowing of
commercial bank.
-> It forces the commercial banks to increase their lending rates, which
discourages borrowers from taking loans, which discourages investment.
-> Again high rate of interest induces households to increase their savings
by restricting expenditure on consumption.
-> Thus, expenditure on investment and consumption is reduced, which
will control the excess demand.
• In a situation of deficient demand leading to deflation,
-> Central bank decreases Repo rate that encourages commercial banks
in borrowing from central bank as it will decrease the cost of borrowing of
commercial bank.
-> Decrease in Repo rate makes commercial bank to decrease their
lending rates, which encourages borrowers from taking loans, which
encourages investment.
-> Again low rate of interest induces households to decrease their savings
by increasing expenditure on consumption.
-> Thus, expenditure on investment and consumption increase, which will
control the deficient demand.
(iii) Reverse Repo Rate
• It is the rate at which the Central Bank (RBI) borrows money from
commercial bank.
• In a situation of excess demand leading to inflation, Reverse repo rate is
increased, it encourages the commercial bank to park their funds with the
central bank to earn higher return on idle cash. It decreases the lending
capability of commercial banks, which controls excess demand.
• In a situation of deficient demand leading to deflation, Reverse repo rate
is decreased, it discourages the commercial bank to park their funds with
the central bank. It increases the lending capability of commercial banks,
which controls deficient demand.
(iv) Open Market Operations (OMO)
• It consists of buying and selling of government securities and bonds in
the open market by Central Bank.
• In a situation of excess demand leading to inflation, central bank sells
government securities and bonds to commercial bank. With the sale of
these securities, the power of commercial bank of giving loans decreases,
which will control excess demand.
• In a situation of deficient demand leading to deflation, central bank
purchases
government securities and bonds from commercial bank. With the
purchase of these securities, the power of commercial bank of giving
loans increases, which will control deficient demand.
(v) Varying Reserve Requirements
• Banks are obliged to maintain reserves with the central bank, which is
known as legal reserve ratio. It has two components. One is the Cash
Reserve Ratio or CRR and the other is the SLR or Statutory Liquidity Ratio.
• Cash Reserve Ratio:
-> It refers to the minimum percentage of a bank’s total deposits, which it
is required to keep with the central bank. Commercial banks have to keep
with the central bank a certain percentage of their deposits in the form of
cash reserves as a matter of law.
-> For example, if the minimum reserve ratio is 10% and total deposits of
a certain bank is Rs. 100 crore, it will have to keep Rs. 10 crore with the
Central Bank.
-> In a situation of excess demand leading to inflation, Cash Reserve Ratio
(CRR) is raised to 20 per cent, the bank will have to keep Rs.20 crore with
the Central Bank, which will reduce the cash resources of commercial
bank and reducing credit availability in the economy, which will control
excess demand.
-> In a situation of deficient demand leading to deflation, cash reserve
ratio (CRR) falls to 5 per cent, the bank will have to keep Rs. 5 crore with
the central bank, which will increase the cash resources of commercial
bank and increasing credit availability in the economy, which will control
deficient demand.
(vi) The Statutory Liquidity Ratio (SLR)
• It refers to minimum percentage of net total demand and time liabilities,
which commercial banks are required to maintain with themselves.
• In a situation of excess demand leading to inflation, the central bank
increases statutory liquidity ratio (SLR), which will reduce the cash
resources of commercial bank and reducing credit availability in the
economy.
• In a situation of deficient demand leading to deflation, the central bank
decreases statutory liquidity ratio (SLR), which will increase the cash
resources of commercial bank and increases credit availability in the
economy.
• It may consist of:
-> Excess reserves
-> Unencumbered (are not acting as security for loans from the Central
Bank) government and other approved securities (securities whose
repayment is guaranteed by the government); and
-> Current account balances with other banks.
(b) Qualitative Instruments or Selective Tools of Monetary
Policy: These
instruments are used to regulate the direction of credit. They are as
under:
(i) Imposing margin requirement on secured loans
• Business and traders get credit from commercial bank against the
security of their goods. Bank never gives credit equal to the full value of
the security. It always pays less value than the security.
• So, the difference between the value of security and value of loan is
called
marginal requirement.
• In a situation of excess demand leading to inflation, central bank raises
marginal requirements. This discourages borrowing because it makes
people gets less credit against their securities.
• In a situation of deficient demand leading to deflation, central bank
decreases marginal requirements. This encourages borrowing because it
makes people get more credit against their securities.
(ii) Moral Suasion
• Moral suasion implies persuasion, request, informal suggestion, advice
and appeal by the central banks to commercial banks to cooperate with
general monetary policy of the central bank.
• In a situation of excess demand leading to inflation, it appeals for credit
contraction.
• In a situation of deficient demand leading to deflation, it appeals for
credit expansion.
(iii) Selective Credit Controls (SCCs)
• In this method the central bank can give directions to the commercial
banks not to give credit for certain purposes or to give more credit for
particular purposes or to the priority sectors.
• In a situation of excess demand leading to inflation, the central bank
introduces rationing of credit in order to prevent excessive flow of credit,
particularly for speculative activities. It helps to wipe off the excess
demand.
• In a situation of deficient demand leading to deflation, the central bank
withdraws rationing of credit and make efforts to encourage credit.

Importance of Central Bank

The central bank is the heart of the monetary system of any
country. A country’s economy is influenced heavily by the actions
taken by its central bank. They are the key governing body that
ensures the boom and bust cycle of the economy and financial
markets does not hamper the direction of the country’s economy. Its
central bank ensures the steady and stable growth of the economy
of a country.

Examples of Central Banks

Some of the well known central banks across the world are:
1. Federal Reserve (USA)

2. Reserve Bank of India (India)

3. People’s Bank of China (China)

4. Bank of England (UK)

5. European Central Bank (EU or European Union)

The
Reserve Bank of India, chiefly known as, RBI is India's central bank and regulatory
body responsible for regulation of the Indian banking system. It is under
the ownership of Ministry of Finance, Government of India. It is responsible for
the issue and supply of the Indian rupee. It also manages the country's main payment
systems and works to promote its economic development. Bharatiya Reserve Bank Note
Mudran is one of the specialised divisions of RBI through which it prints & mints Indian
bank notes and coins. RBI established the National Payments Corporation of India as one of
its specialised division to regulate the payment and settlement systems in India. Deposit
Insurance and Credit Guarantee Corporation was established by RBI as one of its specialised
division for the purpose of providing insurance of deposits and guaranteeing of credit
facilities to all Indian banks.
Until the Monetary Policy Committee was established in 2016,[6] it also had full control
over monetary policy in the country.[7] It commenced its operations on 1 April 1935 in accordance
with the Reserve Bank of India Act, 1934.[8] The original share capital was divided into shares of
100 each fully paid.[9] Following India's independence on 15 August 1947, the RBI was
nationalised on 1 January 1949.[10]

The overall direction of the RBI lies with the 21-member central board of directors, composed of:
the governor; four deputy governors; two finance ministry representatives (usually the Economic
Affairs Secretary and the Financial Services Secretary); ten government-nominated directors;
and four directors who represent local boards for Mumbai, Kolkata, Chennai, and Delhi. Each of
these local boards consists of five members who represent regional interests and the interests of
co-operative and indigenous banks.
It is a member bank of the Asian Clearing Union. The bank is also active in promoting financial
inclusion policy and is a leading member of the Alliance for Financial Inclusion (AFI). The bank is
often referred to by the name 'Mint Street'.[11]
On 12 November 2021, the Prime Minister of India, Narendra Modi, launched two new schemes
which aim at expanding investments and ensuring more security for investors. The two new
schemes include the RBI Retail Direct Scheme and the Reserve Bank Integrated Ombudsman
Scheme.[12] The RBI Retail Direct Scheme is targeted at retail investors to invest easily in
government securities. According to RBI, the scheme will allow retail investors to open and
maintain their government securities account free of cost. The RBI Integrated Ombudsman
Scheme aims to further improve the grievance redress mechanism for resolving customer
complaints against entities regulated by the central bank. The RBI makes it mandatory for all the
banks in India to have a safe box in their own respect strong room. However, exception is given
to the Regional Banks and the SBI branches located in the rural areas but a strong room is
compulsory.

conclusion