Functions of Central Bank

Last Updated On -16 Apr 2025

The central bank is one of the crucial pillars of monetary stability. It is the peak financial institution of a country which guards the monetary and banking system. The role extends beyond currency issuance- it ensures the regulation of money supply, supervises other banks, manages the foreign exchange reserves and helps in shaping the economy through the implementation of policies. They play a significant role in macroeconomic and microeconomic forecasting which helps during economic turbulence.

What is the Central Bank?

The aftermath of World War I, led to the uprising of the Central bankers of the United Kingdom and the United States respectively. After that, central banks have received a distinguished treatment from other financial institutions. It is a national institution that operates either independently or semi-independently of the government. Unlike the commercial banks, a central bank is not for the general public. It serves the government and financial institutions. Examples are the Reserve Bank of India (RBI), the Federal Reserve in the United States, and the Bank of England.

Central banks are non-profit institutions with the primary objective of maintaining economic stability. They have a long-lasting impact on inflation, employment, currency strength, and even global trade. Each nation entrusts the central bank with key responsibilities to shape the financial system of the nation.

What are the key functions of a Central Bank?

The central bank is the backbone of the economy. All the major financial decisions from the inflation control to the availability of credit, it all depends on the central bank policies. The decisions affect the interest rates, exchange rates, business investments, consumer spending, and at last affect the growth trajectory of a country. During economic recessions or a global financial crisis, the central bank intervenes and helps in stabilizing the market and restoring confidence.

The key functions of the central bank are listed below:

1. Issuer of Currency

The issuance of the nation’s legal tender currency is an essential function of the central bank. For example, in India, the Reserve Bank of India has the authority to print and circulate currency notes, except for the one-rupee note which is issued by the Ministry of Finance. The power makes sure that there is uniformity in the currency system and helps in the regulation of inflation and liquidity. The central bank makes sure that the currency in circulation is genuine and supplied adequately, and supported by appropriate reserves.

2. Custodian of Foreign Exchange Reserves

The central bank manages the foreign exchange reserves of the country and stabilizes the currency in the international market. It regulates the exchange rate system, fixed, floating, or managed, monitors the inflow and outflow of foreign capital, and interferes in the forex markets when it is necessary. These actions help in maintaining the value of the national currency. It helps in supporting international trade. In times of economic crisis the central bank makes decisions in the favor of prevention of the crisis.

3. Banker to the Government

The central banks are the government's banker, agent, and debt manager. The central bank helps in the maintenance of government accounts, public debts, and receipts and payments. They also advise the government on monetary matters and economic planning. In a lot of countries, the central bank plays an important role in financial systems through the issuance of bills and government bonds.

4. Controller of Credit (Monetary Policy)

The central bank formulates and implements policies related to the monetary issues to control the supply of money and credit in the economy. The adjustment of interest rates, reserve ratios, and open market operations helps in combating inflation, stimulating investments, and controlling demand. The main goal is to maintain the stability of prices while also supporting economic growth. There are tools like repo rate, CRR (cash reserve ratio), and SLR (Statutory Liquidity Ratio) that helps the central bank in influencing the liquidity in the banking systems.

5. Lender of the Last Resort

In times of banking crisis or financial instability, the central bank comes in as a lender of the last resort. If commercial banks face the liquidity issue situation and cannot meet their duties, the central bank lends money to prevent any kind of bank failure and maintains the trust in the financial system. This key function of the central bank maintains public confidence and economy during unfortunate times.

6. Custodian of Cash Reserves of Commercial Banks

The central banks have a requirement to maintain the percentage of their deposits as reserves which is known as the Cash Reserve Ratio (CRR). This reserve ensures the solvency of commercial banks and provides the central bank a tool to control the overall money supply. After increasing or decreasing the CRR, the central bank directly affects the lending capacity of banks and hence, manages the inflation. This encourages economic activity.

7. Supervisor and Regulator of Banks

The central bank regularizes and supervises all the commercial banks and financial institutions for an efficient banking system. It lays down rules for licensing, minimum capital requirements,and risk management. It also audits and inspects the health of banking sectors. This particular function of the central bank supports the financial system and prevents unfair practices.

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Frequently Asked Questions (FAQs)

State the difference between central and commercial banks?

A central bank plays the role of regulation and supervising the banking system. There is no public interaction. Whereas the commercial bank caters to individuals by accepting deposits, provision of loans and financial services.