The central bank is an apex financial institution in the banking system and is considered an integral part of the economic and financial system of a nation. The functions of the central bank can be summarized as follows:
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Bank to the government: One of the important functions of the central bank is to act as the bank to the government. The central bank accepts deposits and issues funds to the government. It is also involved in making and receiving payments for the government. Central banks also offer short-term loans to the government in order to recover from bad phases in the economy.
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Advisor and agent of the government: In addition to being the bank to the government, the central bank acts as an advisor and agent of the government by providing advice to the government in areas of economic policy, capital market, money market, and loans from the government. In addition to that, the central bank is instrumental in the formulation of monetary and fiscal policies that help in the regulation of money in the market and controlling inflation.
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Clearing house for transfer and settlement: Central bank acts as a clearing house of the commercial banks and helps in settling mutual indebtedness of the commercial banks. In a clearing house, the representatives of different banks meet and settle the interbank payments.
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Controller of credit: Central banks also function as the controller of credit in the economy. It happens that commercial banks create a lot of credit in the economy that increases inflation. The central bank controls the credit creation by commercial banks by regulating the amount of deposits, cash reserves, and rate of interest given.
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Bank of issue: Central banks have the exclusive right to issue notes (currency) in every country of the world. In the initial years of banking, every bank enjoyed the right of issuing notes, but later on, this right was given to the central bank.
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Regulator of commercial banks: Central banks regulate commercial banks by setting and enforcing prudential regulations, such as capital adequacy requirements, reserve ratios, and inspection of returns filed by them on a periodic basis.
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Lender of last resort: Central banks can lend to failing financial institutions and even governments as a lender of last resort. The primary goal of central banks is to provide their countries currencies with price stability by controlling inflation.
In summary, the central bank is responsible for controlling, regulating, and stabilizing the monetary and banking framework of a country.
