The central bank generally performs the following functions:
1. Bank of Note Issue:
The central bank has the sole monopoly of note issue in almost every country. The currency notes printed and issued by the central bank become unlimited legal tender throughout the country.
In the words of De Kock, “The privilege of note-issue was almost everywhere associated with the origin and development of central banks.”
However, the monopoly of central bank to issue the currency notes may be partial in certain countries. For example, in India, one rupee notes are issued by the Ministry of Finance and all other notes are issued by the Reserve Bank of India.
The main advantages of giving the monopoly right of note issue to the central bank are given below:
(i) It brings uniformity in the monetary system of note issue and note circulation.
(ii) The central bank can exercise better control over the money supply in the country. It increases public confidence in the monetary system of the country.
(iii) Monetary management of the paper currency becomes easier. Being the supreme bank of the country, the central bank has full information about the monetary requirements of the economy and, therefore, can change the quantity of currency accordingly.
(iv) It enables the central bank to exercise control over the creation of credit by the commercial banks.
(v) The central bank also earns profit from the issue of paper currency.
(vi) Granting of monopoly right of note issue to the central bank avoids the political interference in the matter of note issue.
2. Banker, Agent and Adviser to the Government:
The central bank functions as a banker, agent and financial adviser to the government,
(a) As a banker to government, the central bank performs the same functions for the government as a commercial bank performs for its customers. It maintains the accounts of the central as well as state government; it receives deposits from government; it makes short-term advances to the government; it collects cheques and drafts deposited in the government account; it provides foreign exchange resources to the government for repaying external debt or purchasing foreign goods or making other payments,
(b) As an Agent to the government, the central bank collects taxes and other payments on behalf of the government. It raises loans from the public and thus manages public debt. It also represents the government in the international financial institutions and conferences,
(c) As a financial adviser to the lent, the central bank gives advise to the government on economic, monetary, financial and fiscal ^natters such as deficit financing, devaluation, trade policy, foreign exchange policy, etc.
3. Bankers’ Bank:
The central bank acts as the bankers’ bank in three capacities:
(a) custodian of the cash preserves of the commercial banks;
(b) as the lender of the last resort; and (c) as clearing agent. In this way, the central bank acts as a friend, philosopher and guide to the commercial banks
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 percentage of its cash balances as deposits with the central banks. These cash reserves can be utilised by the commercial banks in times of emergency.
The centralization of cash reserves in the central bank has the following advantages:
(i) Centralised cash reserves inspire confidence of the public in the banking system of the country.
(ii) Centralised cash reserves provide the basis of a larger and more elastic credit structure than if these amounts were scattered among the individual banks.
(iii) Centralised reserves can be used to the fullest possible extent and in the most effective manner during the periods of seasonal strains and financial emergencies.
(iv) Centralised reserves enable the central bank to provide financial accommodation to the commercial banks which are in temporary difficulties. In fact the central bank functions as the lender of the last resort on the basis of the centralised cash reserves.
(v) The system of contralised cash reserves enables the central bank to influence the creation of credit by the commercial banks by increasing or decreasing the cash reserves through the technique of variable cash-reserve ratio.
(vi) The cash reserves with the central bank can be used to promote national welfare.
4. Lender of Last Resort:
As the supreme bank of the country and the bankers’ bank, the central bank acts as the lender of the last resort. In other words, in case the commercial banks are not able to meet their financial requirements from other sources, they can, as a last resort, approach the central bank for financial accommodation. The central bank provides financial accommodation to the commercial banks by rediscounting their eligible securities and exchange bills.
The main advantages of the central bank’s functioning as the lender of the last resort are :
(i) It increases the elasticity and liquidity of the whole credit structure of the economy.
(ii) It enables the commercial banks to carry on their activities even with their limited cash reserves.
(iii) It provides financial help to the commercial banks in times of emergency.
(iv) It enables the central bank to exercise its control over banking system of the country.
5. Clearing Agent:
As the custodian of the cash reserves of the commercial banks, the central bank acts as the clearing house 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 with least use of cash. The clearing house function of the central bank has the following advantages:
(i) It economies the use of cash by banks while settling their claims and counter-claims.
(i) It reduces the withdrawals of cash and these enable the commercial banks to create credit on a large scale.
(ii) It keeps the central bank fully informed about the liquidity position of the commercial banks.