INDEX

CHAPTER.

PARTICULARS

PAGE

NO

NO.

INTRODUCTION

HISTORY OF CENTRAL BANK

OWNERSHIP OF RBI

OBJECTIVES OF CENTRAL BANKS

FUNCTIONS OF A CENTRAL BANK

MEASURES

OF

CREDIT

CONTROL

BY

CENTRAL BANK
7

8
9

THE IMPORTANT ROLES PLAYED BY CENTRAL BANK

INDEPENDENCE
DIFFERENCES BETWEEN A CENTRAL BANK AND
A COMMERCIAL BANK

10

CONCLUSION

1. INTRODUCTION

The Central Bank is the bank which stands as the lender of money, issue notes
and coins, supervises, controls and regulates the activities of the banking system
and acts as the banker to the government .In the pyramidal financial structure of a
modern economy the central bank lies at the top. In other words, the central bank
acts as the head of the banking institution in the country. The central bank is the
apex institution of the monetary and banking structure of the country. It seeks to
manage a macro economy in such a fashion as to promote social welfare. At
present there is no country in the world of any importance that does not have a
central bank. The establishment of a central bank in a modern economy is essential
as it is the apex institution of a country's financial as well as monetary system.
Thus, every independent country should have a central bank for organizing,
running, supervising, regulating and developing its monetary system. Moreover,
implementation of the government's economic policy requires the presence of
central bank which stands as the undisputedleader of the money market. Thus, the
central bank is one of theinventions of modern civilization.
The Riks Bank of Sweden was set up in 1656 and the Bank of England was
started in 1964. However, Bank of England started functioning as the Central
Bank of England in 1884. the Bank of England is the oldest Central Bank in the
world. thus, the first Central Bank was established in eighteenth century. Twelve
Federal Reserve Banks in America started functioning in 1913. A phenomenal
growth of central bank took place in various countries after the second world war.
there are nearly 150 central banks operating throughout the world. in each and

every country there is a central bank. the twelve federal reserve banks in America
are quasi government banks. the coordinating central body of these banks is the
Federal Reserve Board. They are an admixture of private ownership and public
control. They are not guided by the profit motive like other private enterprises.
The Reserve Bank of India, the Central Bank of our country was set up in 1935.
The evolution of central banking was traced out from the note issuing function
of banking system. Commercial banks were given powers to issue currency notes
in nineteenth century. However, there were problems in issuing notes due to lack of
uniformity, over-issue or under-issue of notes. Therefore, note-issuing powers were
gradually shifted to the Central Bank i.e. the Reserve Bank of India.

2. History of central bank

Prior to the 17th century most money was commodity money, typically gold or
silver. However, promises to pay were widely circulated and accepted as value at
least five hundred years earlier in both Europe and Asia. The Song Dynasty was
the first to issue generally circulating paper currency, while the Yuan Dynasty was
the first to use notes as the predominant circulating medium. In 1455, in an effort
to control inflation, the succeeding Ming Dynastyended the use of paper money
and closed much of Chinese trade. The medieval European Knights Templar ran an
early prototype of a central banking system, as their promises to pay were widely
respected, and many regard their activities as having laid the basis for the modern
banking system.
As the first public bank to "offer accounts not directly convertible to coin",
the Bank of Amsterdam established in 1609 is considered to be the precursor to
modern central banks. The central bank of Sweden ("Sveriges Riks bank" or
simply "Riks banker") was founded in Stockholm from the remains of the failed
bank Stockholms Banco in 1664 and answered to the parliament ("Riksdag of the
Estates").One role of the Swedish central bank was lending money to the
government.
In England in the 1690s, public funds were in short supply and were needed to
finance the ongoing conflict with France. The credit of William III's government
was so low in London that it was impossible for it to borrow the 1,200,000 (at 8
per cent) that the government wanted.
In order to induce subscription to the loan, the subscribers were to
be incorporated by the name of the Governor and Company of the Bank of
England. The bank was given exclusive possession of the government's balances,

and was the only limited-liability corporation allowed to issue bank-notes. The
lenders would give the government cash (bullion) and also issue notes against the
government bonds, which can be lent again. The 1.2M was raised in 12 days; half
of this was used to rebuild the Navy.
The establishment of the Bank of England, the model on which most modern
central banks have been based on, was devised by Charles Montagu, 1st Earl of
Halifax, in 1694, to the plan which had been proposed by William Paterson three
years before, but had not been acted upon. He proposed a loan of 1.2M to the
government; in return the subscribers would be incorporated as The Governor
and Company of the Bank of England with long-term banking privileges
including the issue of notes. The Royal Charter was granted on 27 July through the
passage of the Tonnage Act 1694.
The War of the Second Coalition led to the creation of the Banque de France in
1800.
Although central banks today are generally associated with fiat money, the 19th
and early 20th centuries central banks in most of Europe and Japan developed
under

the

international gold

standard,

elsewhere free

banking or currency

boards were more usual at this time. Problems with collapses of banks during
downturns, however, were leading to wider support for central banks in those
nations which did not as yet possess them, most notably in Australia.
The US Federal Reserve was created by the U.S. Congress through the passing
of The Federal Reserve Act in the Senate and its signing by President Woodrow
Wilson on the same day, December 23, 1913. Australia established its first central
bank in 1920, Colombia in 1923, Mexico and Chile in 1925 and Canada and New
Zealand in the aftermath of the Great Depression in 1934. By 1935, the only
significant independent nation that did not possess a central bank was Brazil,

which subsequently developed a precursor thereto in 1945 and the present central
bank twenty years later. Having gained independence, African and Asian countries
also established central banks or monetary unions.
The People's Bank of China evolved its role as a central bank starting in about
1979 with the introduction of market reforms, which accelerated in 1989 when the
country adopted a generally capitalist approach to its export economy. Evolving
further partly in response to the European Central Bank, the People's Bank of
China has by 2000 become a modern central bank. The most recent bank model,
was introduced together with the euro, involves coordination of the European
national banks, which continue to manage their respective economies separately in
all respects other than currency exchange and base interest rates.

3. OWNERSHIP OF RBI
The Reserve Bank of India was constituted as a shareholder's bank, based on the
model of leading foreign central banks. The share capital of the bank was Rs. 5
crores divided into shares of Rs. 100 each. Rs.2,20,000 were subscribed by the
Central Government and remaining amount was subscribed by the private
Shareholders. After independence, the government of India took decision to
nationalized the Reserve Bank, realising the need for a close integration of the
monetary and credit policies of the bank and macro-economic policies of the
Government .
The Reserve Bank (Transfer to Public Ownership ) act, 1948 was passed and the
Government took over the reserve bank of India from private shareholders by
paying adequate compensation to them. from 1 stJanuary, 1949 the Reserve Bank of
India started functioning as a state-owned central banking institution.

4. OBJECTIVES OF CENTRAL BANKS

The aim of the Central Bank is to regulate the issue of bank notesand keeping of
reserve with a view to securing monetary stability inthe country and to operate
currency and credit system of the countryto its advantage. At the same time
pressing the necessity to establisha Central Bank in India, Hilton Young
Commission stressed the need foreradication of weakness lying in the times before
the establishment ofthe Reserve Bank of India.
Following are the important objectives ofestablishment of a central bank in
the country :I.

Maintain value of currency

It is necessary to Maintain the value of currency of a country stable. The central

bank assumes the function of controller of currency, to secure monetary stability in

the country. The establishment of the Reserve Bank of India was also thought to br
necessary to maintain the value of rupee stable.

II.

Appropriate Credit Policy The Central Bank of a country has to pursue an appropriate credit policy for the

country. In India, the Reserve Bank of India was given the power to pursue an
appropriate credit policy. Accordingly the RBI can control the credit created by the
banks in the country by its bank rate policy and other weapons which it has been
vested by virtue of various statutes, particularly Reserve Bank of India Act and the
Banking Regulation Act.

III.

To act as Banker's Bank

The Central Bank act as a banker's bank. The Reserve Bank of India is a

banker's bank which has control over the cash reserves of the commercial banks.
In India, RBI act as Central Bank and it provides loans and advances to medium
and small scale banks.
IV.

Control over banking systemThe Reserve Bank of India has been given powers to issue licences to the

banking companies in the country. It can also inspect the books of accounts of the
banking companies and issue them appropriate directions.
V.

Leadership in money market

Another objective of the central bank was to remove structurak instability of the
banking systems and to provide leadership ti the money market. The Financial
Institutions and Banks can also do the same process for other subjects.

5. FUNCTIONS OF A CENTRAL BANK

There are certain difference in the style of functioning of a central bank in
different countries. its function in a less developed country differ from those in a
developed country. In developed Banks, such as the Federal Reserve Board in the
United States, conduct a wide range of banking, regulatory and supervisory
functions. They have substantial public responsibilities and a board array of
executive powers. Central Banking, perform certain common but vital functions in
every country.
The central bank generally performs the following functions :1. Monopoly of note-issue.
2. Banker, agent and adviser to the government.
3. Custodian of cash reserves of commercial banks.
4. Custodian of nations reserves of international currencies.
5. Lender of the last resort
6. Clearing house function
7. Credit control
Besides the aforesaid seven functions there are some other functions also,
namely:
(i) Collection of data.
(ii) Role of central bank in developing countries.
(iii) Central bank and industrial and agricultural development.

(iv) International financial institutions.

1. Monopoly of Note-Issue:
Note-issue primarily is the main function of a central bank in every country.
These days, in all the countries where there is a central bank generally it has got
the monopoly or the sole right of note-issue.
In the beginning this was not the function of Central Bank but gradually all the
central banks have acquired this function. First of all, Central Bank of England got
the right of note-issue in the year 1844. In actual practice, upto the beginning of
twentieth century, generally central banks were recognized as the banks of noteissue. In India, R.B.I., the central bank of India has got the right of note-issue.
2. Banker, Agent & Adviser to the Government:
As banker to the government, central bank provides all those services and
facilities to the government which public gets from the ordinary banks. It operates
the accounts of the public enterprises. It manages government departmental
undertakings and government funds and when there is a need gives loans to the
government. It looks after the management of public debt. It accepts the payment
of taxes from the public on behalf of the government and makes payment for the
cheques issued by the government. It also undertakes transactions relating to
foreign currencies on behalf of the government.
3. Custodian of Cash Reserves of Commercial Bank:
Central bank is the bank of banks. This signifies that it has the same relationship
with the commercial banks in the country which they have with their customers. It
provides security to their cash reserves, gives them loan at the times of need, gives

them advice on financial and economic matters and works as clearing house among
various member banks.
A definite percentage of deposits of commercial banks are kept as reserve with
the central bank. This leads to centralisation of cash reserve and facilitates working
of credit control. These funds are of great significance during the time of
emergency.
4. Custodian of Nation's Reserves of International Currencies:
Central bank is the custodian of the foreign currency obtained from various
countries. This has become an important function of central bank, these days,
because with its help it can stabilize the external value of the currency. This
function has become highly important after the World Depression of 1929 and the
establishment of the International Monetary Fund.
5. Lender of the Last Resort:
Central bank works as lender of the last resort for commercial banks because in
the times of need it provides them financial assistance and accommodation.
Whenever a commercial bank faces financial crisis, central bank as lender of the
last resort comes to its rescue by advancing loans and the bank is saved from being
failed. Central bank helps commercial banks by discounting their bills and
securities.
6. Clearing House Function:
All the commercial banks have their accounts with the central bank. Therefore,
central bank settles the mutual transactions of banks and thus saves all banks
contacting each other individually for setting their individual transactions, in this
way; the unnecessary cash transactions between individual banks are avoided.

7. Credit Control:
This is a very important function. These days, the most important function of
central bank is to control the volume of credit for bringing about stability in the
general price level and accomplishing various other socio-economic objectives.
There are number of methods which a central bank may use for controlling the
volume of credit such as bank rate, open market operations, change in reserve ratio
and various selective controls. These methods have been discussed in detail in the
next question.

5. MEASURES OF CREDIT CONTROL BY CENTRAL BANK

The Central Bank of a country has the responsibility of controlling the volume
and direction of credit in the economy in order to achieve the objective of growth
with stability.
The Central Bank adopts two types of measures for controlling credit activities
of the bank in the economy.
These are :(A) Quantitative Measures Of Credit Control
(B) Qualitative or Selective Measures of Credit Control.

A) Quantitative Measures Of Credit Control

These measures are macro economic in effect and are used to control the
inflationary or deflationary pressures caused by expansion or contraction of credit.
The measures also aim at controlling the cost of credit.
These include :(1) Bank Rate
(2) Open Market Operations
(3) Varying Reserve Ratio or Cash Reserve Ratio (C.R.R.)

(1) Bank Rate

Bank rate is the minimum rate of interest charged by the Central Bank to
commercial banks while giving loans to them against eligible securities or by
rediscounting bills of exchange. It is called rediscount rate. The Bank Rate affects
both the cost and availability of credit. The Bank Rate is important because it is the
pace setter to other market rates of interest. The money market rates adjust
automatically to the changes in Bank Rate. The Central Bank can raise or reduce
the Bank Rate to increase or decrease the money supply in the economy.
When the Bank Rate is increased, the cost of borrowing from Central Bank goes
up, which in turn forces the commercial banks to charge higher lending rate to
cover up their increased cost. Businessmen and industrialists (i.e. entrepreneurs)
feel discouraged to borrow more money, when the lending rate of interest charged
by commercial banks is high. This would lead to contraction in bank credit and a
decrease in money supply in the economy. The reduction in money supply will
reduce aggregate demand or money expenditure. As a result prices will fall and
inflation will be checked. Central Bank follows this Dear Money Policy during
the period of inflation to control general rises in prices of all goods and services.
The reverse will happen when the Bank Rate is reduced in order to overcome
the problem of recession or depression in the economy. This is called Cheap
Money Policy of the Central Bank.
The R.B.I. started with a cheap money policy with a Bank Rate of 3% in 1935.
This rate has undergone a lot of changes time and again as per the requirements of
the economy.

2) Open Market Operations

Open Market Operations refer to deliberate buying and selling of government
securities and treasury bills by the Central Bank in the open market. By doing so
the Central Bank can increase or decrease cash reserves of the banks. O.M.O. is an
important instrument of stabilizing the general price level. It affects the money
supply directly and rate of interest indirectly.
When the Central Bank sells securities to the public, commercial banks and
other financial institution in the open market, payments are usually made by
cheques. Money flow a from them to Central Bank. This reduces the demand
deposits held by the public and the cash reserve of banks, which in turn reduces
their ability to create credit. Thus the sale of securities by the Central Bank leads to
a decrease in quantity of money supply in the economy and rise in market rate of
interest. This in turn reduces the demand for money, due to a higher cost and thus
helps to check inflationary tendencies in the economy.

3) Variable Cash Reserve Ratio .

Lord J.M. Keyns has popularized this as a method of credit control by the
Central Bank.
I.

Cash Reserve Ratio (C.R.R.)

By the Banking Act, commercial banks have to maintain a certain amount of

cash with Central Bank (for e.g. RBI) as reserves against their demand and time
deposits. (Under the RBI Act of 1935 every commercial bank has to keep certain
minimum cash reserves with the RBI. It can very C.R.R. between 3% and 15% of
total time and demand deposits.)

This amount cannot be used by banks for lending activities. Therefore, the
amount available for lending gets reduced to the extent of Cash Reserve Ratio.
This reserve ratio is changed to regulate credit. It directly affects the lending
capacity of banks and the rate of interest charged by banks.
An increase in Cash Reserve Ratio leads to a contraction of credit, increase in
lending interest rate and a reduction in money supply in the economy. This can
reduce inflationary pressures.
An decrease in Cash Reserve Ratio leads to an expansion of credit, a decrease in
lending interest rate and an increase in money supply in the economy.
When Central Bank wants to reduce money supply, the C.R.R. will be raised,
and it will be reduced the quantity of money. It is a very effective instrument as it
affects the base of credit creation.

II.

Statutory Liquidity Ratio (SLR)

In addition to CRR, the commercial banks have to maintain a certain

percentage (25%) of their total demand and time deposits with the RBI in the
form of liquid assets i.e. in the form of cash, gold and in approved securities. This
is known as Statutory Liquidity Requirement. This amount is kept in reserve to
invest in government securities, as every commercial bank has to make these
investments. Hence, it is not available to banks for lending purposes.
If Central Bank wants to decrease money supply in the economy, it will increase
SLR, which will reduce commercial banks ability to create credit. A higher SLR
will increase the lending rates of banks. If the Central Bank wants to increase

money supply in the economy, it will reduce SLR which will increase banks
ability to create credit. A lower SLR reduces the lending rate of banks.
c) Concept Repo Rate and Bank Rate
People often get confused between these two terms. Though they appear
similar, there is a basic difference between them.
a) Repo Rate or Purchase Rate i.e. Liquidity Adjustment Facility (LAF)
Repo Rate or Repurchase Rate is that rate at which commercial banks borrow
money from the Central Bank for short period by selling their securities to the
Central Bank with an agreement to repurchase them at a future date at predetermined price.
Bank Rate is the rate at which banks borrow money from the Central Bank,
without any sale of securities. It is generally for a longer period of time. These
two rates are determined by central bank of country on the basis of demand for and
supply of money in an economy.
b) Concept of Reserve Repo Rate
Reserve Repo Rate is the rate at which the Central Bank borrows funds from
other commercial banks for a short duration. The commercial banks deposit their
short term excess funds with the central bank and earn interest on it.
Reserve Repo Rate is used by the central bank to absorb liquidity from the
economy. When it feels that to much money floating in the market, it increase the
Reverse Repo Rate, meaning that the Central Bank will pay a higher rate of interest
to the banks for depositing money with it.

An increase in the Reverse Repo Rate cause the banks to transfer more funds to the
Central Bank, because banks earn attractive interest rates and also their money is in
safe hands. This result in the money withdrawn out of the banking system, Thus
banks are left with lesser funds.
Thus, by lowering repo rate, Central Bank injects liquidity Reverse Repo Rate,
It absorbs that liquidity from the banking system.

B) Qualitative or Selective Measures of Credit Control.

1. Margin Requirements:
Banks are required by law to keep a safety margin against securities on which
they lend. The central bank may direct banks to raise or reducethe margin. In the
U.S.A. before World War II, the Federal Reserve Board xed amargin of 40 per
cent (i.e., a bank could lend up to 60 per cent of the value of security). But during
the war and later, the margin requirements were raised from40 per cent to 50 per
cent, then to 75 per cent and in 1946 to 100 per cent in somecases. When the
margin was raised to 75 per cent one could borrow only 25 per cent of the value of
the security and when the margin requirement was xed at 100 percent one could
borrow nothing. Thus by raising the margin requirement, the central bank could
reduce the volume of bank credit which a commercial bank can grant and a party
can borrow. Margin requirement is a good tool to reduce the degree andextent of
speculation in commodity market and stock exchanges.

2. Regulation of Consumer Credit:

During the Second World War an acute scarcity of goods was felt in the U.S.A.,
and the position was worsened by the system of bank credit to consumers to enable
them to buy durable and semi-durable consumer goods throughinstalment buying.
The Federal Reserve Banks of the U.S.A., were authorised to regulatethe terms and
conditions under which consumer credit was extended by commercial banks. The
restraints under these regulations were two-fold:
(a) They limited the amount of credit that might be granted for the purchase of any
article listed in the regulations; and
(b) they limited the time that might be agreed upon for repaying the obligation.
Suppose a buyer was required to make a down-payment of one-third of the
purchase price of a car and the balance to be paid in 15 monthly instalments.
Under the regulations restraining consumer credit, the down-payment was made
larger and the time allowed was madeshorter. The result was a reduction in the
amount of credit extended for the purchase of cars and the time it was allowed to
run; and the ultimate result was the restriction, in the demand for consumer goods
at a time when there was a shortage in supply and when there was a necessity for
restriction on consumer spending. This measure was a success in America in
controlling inationary pressures there. In the past-war period, it

has been

extensively adopted in all those countries where the system of consumer credit is
common.
3. Rationing of Credit:
Rationing of credit, as a tool of selective credit control, originated in England in
the closing years of the 18th century. Rationing of credit implies two things. First,
it means that the central bank xes a limit upon its rediscounting facilities for any

particular bank. Second, it means that the central bank xes the quota of every
afliated bank for nancial accommodation from the central bank. Rationing of
credit occupies an important place in Russian Economic Planning. The central
bank of the Russian Federation allocates the available funds among different banks
in accordance with a denite credit plan formulated by the Planning Commission.
But the criticism of rationing of credit is that it comes into conict with the
function of the central bank as a lender of the last resort. When the central bank
acts as a lender of the last resort it cannot deny accommodation to any bank
through it has borrowed in excess of its quota. Moreover, this method proves
effective only when the demand for credit exceeds the supply of it.
4. Control through Directives:
In the post-war period, most central banks have be invested with the direct
power of controlling bank advances either by statute or by mutual consent between
the central bank and commercial banks. For instance, the Banking Regulation Act
of India in 1949 specically empowered the Reserve Bank of India to give
directions to commercial banks in respect of their lending policies, the purposes for
which advances may or may not be made and the margins to be maintained in
respect of secured loans. In England, the commercial banks have been asked to
submit to the Capital Issue Committee all loan applications in excess of 50,000.
There is no uniformity in the use of directives to control bank advances. On the
one extreme, the central bank may express concern over credit developments; the
concern may be combined with mild threat to avoid increase or decrease in the
existing level of bank loans. On the extreme, there can be a clear and open threat to
the commercial banks nancing certain types of activities.

5. Moral Suasion:
This is a form of control through directive. In a period of depression, the central
bank may persuade commercial banks to expand their loans and advances, to
accept inferior types of securities which they may not normally accept, x lower
margins and in general provide favourable conditions to stimulate bank credit and
investment. In a period of inationary pressure, the central bank may persuade
commercial banks not to apply for further accommodation or not to use the
accommodation already obtained for nancing speculative or non-essential
activities lest inationary pressure should be further worsened. The Bank of
England has used this method with a fair measure of success. But this has been
mainly because of a high degree of co-operation which it always gets from the
commercial banks.
6. Direct Action:
Direct action or control is one of the extensively used methods of selective
control, by almost all banks at sometime or the other. In a broad sense, it includes
the other methods of selective credit controls. But more specically, direct action
refers to controls and directions which the central bank may enforce on all banks or
any bank in particular concerning lending and investment. The Reserve Bank of
India issued a directive in 1958 to the entire banking system to refrain from
excessive lending against commodities in general and forbidding commercial
banks granting loans in excess of Rs. 50,000 to individual parties against paddy
and wheat. There is no doubt about the effectiveness of such direct action but then
the element of force associated with direct action is resented by the commercial
banks.

7. Publicity:
Under this method, the central bank gives wide publicity regarding the probable
credit control policy it may resort to by publishing facts and gures about the
various economic and monetary condition of the economy. The central bank brings
out this publicity in its bulletins, periodicals, reports etc.

6. THE IMPORTANT ROLES PLAYED BY CENTRAL BANK

In the developing countries, the central bank has to play a much wider role.
Besides performing the traditional functions, the central bank has to undertake
responsibility of economic growth with stability in these economies. Moreover,
since the developing countries do not have well- organised money and capital
markets, the central bank has a crucial function to develop the banking and
financial system of the country. The central bank performs the following
developmental and promotional functions in the developing countries.
1. Traditional Functions:
The central banks in the developing countries perform both traditional and nontraditional functions. The traditional functions of the central bank are : having the
monopoly of note-issue; acting as banker to the government; serving as bankers'
bank; functioning as the lender of the last resort; controlling and regulating the
credit; and maintaining the external stability.
2. Economic Growth:
The central banks in the developing countries should aim at promoting the
process of economic growth. Economic growth requires sufficient financial
resources. The central bank can ensure adequate monetary expansion in the
country. Moreover, as a banker to the government, the central bank can provide
funds for initiating investment in the public sector.

3. Internal Stability:
Along with the objective of economic growth, the central bank should also
attempt to maintain internal price stability. The developing countries are
susceptible to inflationary pressures mainly due to supply -in elasticities in the
short period. The central bank should adopt such a monetary policy that can control
inflationary tendencies and ensure price stability.
4. Development of Banking System:
The developing and underdeveloped countries do not have well-developed
banking system. In such an economy, the central bank should not only take
measures to develop an integrated commercial banking system, but also should not
hesitate undertaking directly the commercial banking functions.
5. Branch Expansion:
In developing countries, the commercial banks generally concentrate their
branches in the urban areas. In order to extend credit facilities to the agricultural
sector, the central bank should prepare programm for branch expansion in the rural
areas.
6. Development of Financial Institutions:
Development of the leading sectors of the economy such as agriculture,
industry, foreign trade, etc. requires long-term finances. For this, the specialised
financial institutions should be established which provide term-loans to these
sectors.

7. Development of Banking Habits:

Through its various credit control instruments (i.e., bank rate, variable cashreserve ratio, etc.) and by providing discounting facilities to the commercial banks,
the central bank exercises full control over the activities of commercial banks. This
creates public confidence in the banking system and helps in the development of
banking habits of the people.
8. Training Facilities:
A major difficulty in developing the banking system in developing countries is
the lack of trained staff. The central bank can provide training facilities to meet the
personnel requirements of the banks.
9. Proper Interest Rate Structure:
The central bank can help in establishing a suitable interest rate structure to
influence the direction of investment in the country. In underdeveloped countries, a
policy of low interest rate is necessary for encouraging investment and promoting
development activities. Again, by adopting different interest rates, the central bank
can increase productive investment and discourage unproductive investment.
10. Other Promotional Roles:
The central bank can provide a number of other promotional facilities. For
example,
(a) it can adopt policies to provide help to the various priority sectors, such as
agriculture;, cooperative sector, small scale sector, export sector, etc.

(b) it can provide guidelines to be followed by the planners about some definite
patterns of economic and investment policies;
(c) it can publish information regarding the state of the economy and promote
research in money and banking.

7. INDEPENDENCE
Over the past decade, there has been a trend towards increasing the
independence of central banks as a way of improving long-term economic
performance. However, while a large volume of economic research has been done
to define the relationship between central bank independence and economic
performance, the results are ambiguous.
Advocates of central bank independence argue that a central bank which is too
susceptible to political direction or pressure may encourage economic cycles
("boom and bust"), as politicians may be tempted to boost economic activity in
advance of an election, to the detriment of the long-term health of the economy and
the country. In this context, independence is usually defined as the central bank's
operational and management independence from the government.
The literature on central bank independence has defined a number of types
of independence.

1. Legal independence
The independence of the central bank is enshrined in law. This type of
independence is limited in a democratic state; in almost all cases the central bank is
accountable at some level to government officials, either through a government
minister or directly to a legislature. Even defining degrees of legal independence
has proven to be a challenge since legislation typically provides only a framework
within which the government and the central bank work out their relationship.

2. Goal independence
The central bank has the right to set its own policy goals, whether inflation
targeting, control of the money supply, or maintaining a fixed exchange rate. While
this type of independence is more common, many central banks prefer to announce
their policy goals in partnership with the appropriate government departments.
This increases the transparency of the policy setting process and thereby increases
the credibility of the goals chosen by providing assurance that they will not be
changed without notice. In addition, the setting of common goals by the central
bank and the government helps to avoid situations where monetary and fiscal
policy are in conflict; a policy combination that is clearly sub-optimal.
3. Operational independence
The central bank has the independence to determine the best way of achieving
its policy goals, including the types of instruments used and the timing of their use.
This is the most common form of central bank independence. The granting of
independence to the Bank of England in 1997 was, in fact, the granting of
operational independence; the inflation target continued to be announced in the
Chancellor's annual budget speech to Parliament.

4. Management independence
The central bank has the authority to run its own operations (appointing staff,
setting budgets, and so on.) without excessive involvement of the government. The
other forms of independence are not possible unless the central bank has a
significant degree of management independence. One of the most common
statistical indicators used in the literature as a proxy for central bank independence
is the "turn-over-rate" of central bank governors. If a government is in the habit of
appointing and replacing the governor frequently, it clearly has the capacity to
micro-manage the central bank through its choice of governors.

8. DIFFERENCES BETWEEN A CENTRAL BANK AND A

COMMERCIAL BANK
There are certain basic differences between a central bank and a commercial
bank. They are:
(i) The central bank is the apex monetary institution, which has been specially
empowered to exercise control over the banking system of the country. The
commercial bank, on the contrary, is a constituent unit of the banking system.
(ii) The central bank does not operate with a profit motive. The primary aim of the
central bank is to achieve the objectives of the economic policy of the government
and maximise the public welfare through monetary measures. The commercial
banks, on the other hand, have profit earning as their primary objective.
(iii) The central bank is generally a state-owned institution, while the commercial
banks are normally privately owned institutions.
(jv) The central bank does not deal directly with the Public. The commercial banks,
on the contrary, directly deal with the public.
(v) The central bank does not compete with the commercial banks. Rather it helps
them by acting as the lender of the last resort.
(vi) The central bank has the monopoly of note-issue, whereas the commercial
banks do not enjoy such right.

(vii) The central bank is the custodian of the foreign exchange reserves of the
country. The commercial banks are only the dealers in foreign exchange.

(viii) The central bank acts as the banker to the government, the commercial banks
act as bankers to the general public.
(ix) The central bank acts as the bankers' bank :
(a) The commercial banks arc required to keep a certain proportion of their
reserves with central bank ;
(b) the central bank helps them at the time of emergency ; and
(c) the central bank acts as the clearing house for the commercial banks. But, the
Commercial banks perform no such function.

9. CONCLUSION

The Central Bank is a monetary authority of the country and has to function in a
of the country and has to function in a manner so as to promote economic manner
so as to promote economic stability and development. stability and development.
Central banks exist for different purposes than commercial banks. They pursue
national welfare, not profits. Their financial results are often a poor guide to their
success.
Central bank gains and losses belong to society. Beyond this, financial results may
be important for a central bank even though it can always create money to pay its
bills, cannot be declared bankrupt by a court, and does not exist to make profits.
Losses or negative capital may raise doubts however erroneous about the
central banks ability to deliver on policy targets, and expose it to political
pressure.

10. BIBLIOGRAPHY

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