Question

Explain the functions of the Central Bank. 

Explain any two functions of a central bank/Reserve Bank of India.

Explain the following function of the Reserve Bank of India:

Banker to the government

Explain the following function of the Reserve Bank of India:

Issue of currency notes

Explain the role of the RBI with respect to the custodian of foreign exchange.

Explain the role of the RBI with respect to promotional and developmental functions.

Explain two promotional and developmental functions of a central bank.

Explain the 'controller of credit' function of a central bank.

Explain the major functions performed by a central bank.

Discuss the various functions performed by the central bank in a developing economy.

State the main functions of the central bank.

Answer 1

The following are the seven major functions of a central bank:

1. Issue of currency notes: The central bank of a country has the exclusive authority to issue currency. The currency issued by the central bank is known as ‘legal tender money’, meaning that its value is backed by the central bank.
2. Banker to the commercial banks: The central bank accepts deposits from the commercial banks and holds them as reserves for them. In addition to this:
   1. Custodian of the cash reserves of the banks: Commercial banks are required to deposit a fixed percentage of their deposits with the Central Bank. These deposits can be used by the central banks to make inter-bank transfers.
   2. Lender of last resort: As the lender of last resort, the central bank is under the obligation to provide funds against securities to the commercial banks as and when needed by them.
   3. Clearing house function: The central bank acts as a clearing house for the commercial banks. As a clearing house, it settles interbank claims and reduces the need for cash reserves by the commercial banks.
3. Banker to the government: The Central bank acts as a banker and financial advisor to the government. In addition to this, it buys and sells securities on behalf of the government, maintains its books of accounts, manages its public debt and also grants loans and advances to the government.
4. Custodian of foreign exchange: All the transactions in foreign exchange are routed through the central bank and any earnings from the foreign exchange are to be deposited with the central bank. By having the custody of foreign exchange reserves, the central bank maintains exchange rate stability and promotes international trade.
5. Controller of credit: The most important function of the central bank is to control the credit creation by the commercial banks. As explained earlier, credit money or bank money is the major component of money supply in a country. Therefore, it is essential that the supply of credit be regulated so as to ensure the smooth functioning of the economy. For this purpose, the central bank adopts various quantitative and qualitative methods of credit control. Quantitative methods aim at controlling the cost and availability of credit, while the qualitative methods influence the use and direction of credit.
6. Collection of data and publicity: Central banks collect different statistical information related to banking, currency and foreign exchange. Thereby, they help in the development of suitable monetary and fiscal policies.
7. Developmental and promotional functions: In addition to the above mentioned functions, the Central bank also supports a variety of developmental and promotional activities, like promoting banking habits among people, establishing specialised financial institutions, providing training to bank professionals, etc.
   1. The central bank is entrusted with the responsibility of developing and promoting a strong banking system. For this purpose, it provides liberal and cheap rediscounting facilities to commercial banks and gives various types of concessions.
   2. A central bank discharges various functions so as to promote the economic development of the country. It assists in the development of financial institutions like 'developmental banks' to provide investable funds for the development of agriculture, industry and other sectors of the economy. It helps in the development of money and capital markets in the country. It also pursues appropriate monetary policy to promote economic development.