Traditional Functions Of Central Bank – To understand the functions the central bank has, we have to first understand the meaning of a central bank, since we already know the rationale for establishing the central bank.
Central Bank Definition – there are no universally accepted definition of a central bank. However, in every country of the world, there is a bank that serves as a banker to the government and other banks and also controls the activities of other banks within the country’s banking business.
In order words, these banker bankers bank carryout the traditional functions of Central Bank, the bank that carry’s out these functions may not be named a Central Bank. The name of the bank may not even contain the name Central bank, but it perform the key traditional functions of Central Bank. For example, the central bank of Britain is called Bank Of England, that of the United States Of America is called the Federal Reserve System and Ghana calls theirs Bank of Ghana.
A Central bank can be defined as the government banker responsible for issuing the national currency and control money supply. Although, some of the banks that changed to Central bank where previously commercial banks, even after they had began to perform the functions of central bank.
The above simply means that the functions a bank performs determine what it is called, when a bank performs the function of a central bank, it becomes a central bank even when the name is not central bank.
Therefore, following this pattern, a Central bank can be defined as a central monetary institution charged with performing the duties of banker’s bank, fiscal agent for the government and managing the monetary system of the country.
Another definition of central bank is a bank that the government set up to help handle its transactions, to coordinate and control the commercial banks and most importantly to help control the nations money supply and credit conditions.
Traditional Functions Of Central Bank
The functions of the central bank are well know by all who are conversant with the happening with the banking system. There are two types of functions the Central bank handle, one is the traditional functions and the other is the developmental functions. On this post, our focus will be on the traditional functions of Central Bank.
Banking Functions
- Issuance and distribution of currency – It is the responsibility of the central bank of a country to issue and distribute the legal tender currency (notes and coins) of that country. This is one of the earliest and primary functions of central banks. At the early stage of banking, individual bank were issuing their own currency notes. This gave room for abuse of currency issue and lack of uniformity. In modern times the law of each country makes it mandatory for the Central bank to serve as a bank of issue. In England, the currency and bank notes Act of 1954 restricted the right to issue notes to the issue to the department of the bank of England. It is important that the right to issue note is harmonized in the central bank because it helps to ensure the homogeneity of the currency. The fact that the notes have government backing also makes it more acceptable than those issued by individuals banks. Moreover , the central bank as a singular issuer of currency is in a better position to monitor and control the issuance of note and hence the money supply.
- Banker And Financial Adviser To The Government – this is a major traditional functions of Central Bank, the central bank keeps major accounts of the government and manages the accounts of government and its agencies. As a government bank, it ensures that money is available to finance het government budgets deficit. It can do this through the issue of government debt instrument, and also the granting of ways and means to the government. Ways and means advances granted by the central bank to the government to cover temporary deficiency in government budgeted revenues. Keeping the accounts of the government at all level also places the central bank at a vantage position to advise the government on financial matters. The central bank assists the government in the preparation of national budget. The central bank also grants major loans in period of crisis such as economic depression or war. It also advises the government on how and when to borrow
- Banker To Other Banks And Financial Institution – A central bank acts as the banker’s bank in the same way banker act as banker to their customers. The central bank of a country keeps bank accounts for commercial and merchant banks and other financial institution operating within the country, including foreign banks. They also maintain accounts for the central banks of other countries and for international financial institution such as bank of international settlement and the international monetary fund. The central bank maintains two types of account for deposit accounts for banks. The first is the statutory deposit accounts. These are those accounts that law compels banks to maintain within the bank such as deposits to meet the minimum cash reserve requirement. In most countries of the world, the government normally stipulates the minimum cash reserve that the bank must maintain with the central bank at each point in time. Failure to reach the prescribed cash reserve requirement attracts penalty for the erring bank. The second type of deposit is known a operational deposit. Bank keep enough money in their accounts with the central bank to enable them make inter-bank settlements. Such inter bank settlements can arise through the clearing of checks or in making payments to other banks for purchases of securities or foreign exchange transactions. As a banker to other banks, the central bank also grant loans and renders other financial assistance to these bank when the need arises. These are, however, done at a penal rate to discourage frequent borrowing by banks.
- Lender Of Last Resort – This traditional functions of Central Bank is an extension of its functions as banker’s bank. However, it is treated as a separate function because of its unique importance. Lender of last resort means that when a bank faces shortage of liquid fund, after it has tried all other sources of fund without success, it can always apply to obtain loans from the central bank as a last resort. In such situation, the central bank will always be prepared to lend. The phrase lender of last resort was made popular in the year 1873 by Walter Bagehot in a publication he made titled Lombard street. Then a lot of banks where facing crisis in Britain. Bagehot argued in his publication that the Bank of England should be ready to lend without stint, as a lender of last resort so as to rescue ailing banks. Central banks normally perform these functions by re discounting of first class bills through discount window operations. It does this on its own conditionally. It can also decide to do this indirectly through the discount houses.
- Clearing And Collection Of Checks And Other Instruments – The central bank of each country operates a clearing house. Checks of commercial banks and other negotiable instruments are cleared (settled) through the clearing house. This function of the Central bank also arose out of its function as the banker’s bank. Since all the bank operating within the system maintain operational deposit accounts at central bank, it became convenient for inter-bank settlements to be made through mere book entries in the record books of the central banks. At the early stage of banking history, inter-bank settlements were done directly between banks. If the customer of Bank A receives a check from a customer of another Bank B and pays the check into his account in Bank A, Bank A then will take the check directly to Bank B, Bank B will confirm whether or not that customer has enough money in his account. Is there is money in the account, it will credit the account of Bank A, Bank A will in turn credit the account of the customer who paid he check. This process is too cumbersome and inconvenient. If for instance, there are fifty commercial banks operating with a locality, and several checks are received by one of the banks, it will cost the bank mush time and money to go to all these banks one by one. The central bank has come in to bridge the gap between banks by providing a clearing house where all the banks come together on each working day. Each bank presents the cheque of the other banks paid into it by her customers to the payee bank. There and then the accounts of those banks are debited and credited accordingly. This makes things easier for the banks and saves them the costs implications. The clearing functions has now become a very important traditional functions of Central Bank. These traditional functions has been evolving over time, we will keep you updated with new functions