Question

What are the important functions of Central bank? Which of these functions are more important in a country like India?

Explain any five functions of the Central Bank of India.

Answer 1

1. Monopoly of Note Issue: Generally, the central bank of a country has the monopoly to issue currency notes. Government grants the exclusive right to the central bank to issue notes on its behalf. In India, one rupee notes are issued by the Ministry of Finance. All other currency notes are issued by the Reserve Bank of India. In order to inspire public confidence in paper currency, the central bank keeps reserves of gold and silver against the issue of notes. 
2. Government's Bank: The central bank acts as a banker, fiscal agent and advisor to the Government. It makes and receives payments on behalf of the Government. It floats and manages public debts for the Government. As a fiscal agent, the central bank advises the Government on matters concerning monetary and banking policies. It also serves as a representative of the Government in international conferences on monetary and economic matters.
3. Controller of Credit: Commercial banks create credit by lending money. They may create too much or too little credit. The level of credit in the country causes fluctuations in the price level. It becomes necessary to exercise control over credit so as to ensure stability in the economy. The central bank exercises strict control on the credit granting capacity of commercial banks. This is the most important function of a central bank. Credit control is both qualitative and quantitative in nature.
4. Custodian of Foreign Exchange: The central bank is the sole custodian of gold and foreign currency reserves of the country. Foreign exchange reserves are needed for making payments to foreign countries. When the balance of payments is unfavourable, foreign exchange resources are reduced. Therefore, the central bank advises the Government to encourage exports and to restrict imports in such a way that the balance of payments may be favourable to the country.
5. Maintaining the Exchange Rate: The central bank makes all possible efforts to maintain a stable exchange rate. Exchange rate is the rate at which the home currency can be exchanged for a foreign currency. The central bank keeps a watch on the exchange rate. Whenever there are wide fluctuations in the exchange rate, the central bank, buys and sells foreign currencies to stabilise the exchange rate. The central bank is authorised to fix and change the exchange rate ratio.
6. Banker's Bank: The central bank acts as a banker to all the commercial banks in the country. As a banker's bank, the central bank provides short-term loans and bill discounting facilities to commercial banks. It also advises the commercial banks on various matters relating to their business. Commercial banks are required to keep a certain proportion of their deposits in the form of cash reserves with the central bank. These reserves enable the central bank to exercise control over credit by commercial banks.
7. Lender of the Last Resort: Whenever a commercial bank needs financial assistance, it may borrow from other commercial banks. But other commercial banks may not be in a position to provide funds to the bank in need. In such a case the central bank provides funds to a commercial bank either by granting loans or by purchasing its securities. In this way the central bank acts as the lender of the last resort.
8. The Clearing House Function: Banks serve as clearing houses, collecting cheques from consumers and submitting them to the drawee banks. Cheques drawn by one bank are transferred to other banks, who must then collect the funds from the drawee banks. To save time, the central bank provides clearing capabilities, allowing banks to set off their cheques on a daily basis.
9. Development Functions: Every central bank performs the traditional and regulatory functions given above. But in a developing country like India, the central bank also performs certain promotional and developmental functions. It tries to provide adequate funds for the development of agriculture, trade, transport and industry.