Question

Bring out the importance of a central bank by making special reference to the functions it performs.

Answer 1

1. Issue of Currency Notes: The central bank has monopoly over issuing currency notes in the country. In order to inspire public confidence in paper currency, the central bank keeps reserves of gold, silver, etc., for issuing currency notes.
2. Banker to the Government: The central bank acts as a banker, agent and advisor to the Government. As a banker, it receives and makes payments on behalf of the Government. The central bank serves as the Government's agent in financial matters. It advises the government on matters relating to monetary and banking policies. 
3. Banker's Bank: The central bank acts as the bank for all commercial banks in the country. When a commercial bank needs funds it can obtain loans and rediscount its bills with the central bank. Therefore, central bank is called 'lender of last resort'.
4. Credit Control: The central bank exercises both qualitative and quantitative control over credit granting capacity of commercial banks in order to maintain stability in prices and foreign exchange. In the absence of such control, commercial banks may lend too much or too little.
5. Custodian of Foreign Currency Reserves: The central bank is the sole custodian of gold, foreign exchange and all other reserves of the country. It manages these reserves judiciously so as to overcome difficulties in balance of payments and to stabilise the exchange rates.
6. Maintenance of Exchange Rate: The central bank monitors the exchange rate of the home currency in relation to foreign currencies. It tries to maintain stability in the exchange rate in order to promote the country's foreign trade and to encourage the flow of foreign investment.