(B) Central Banks
i) Importance of central banks: Today in every country wherever commercial banks exist, a central bank is a must. Central banks have been established and have come into prominence in the present century. With the progress of the banking business, central banks acquire an essential role. Modern central banks, like the Federal Reserve Bank, the Bank of England, the Reserve Bank of India etc. perform a variety of functions. These functions are placed under three categories:
- To act as a banker to the government,
- To function as a íbankerís bankí, and
- To control the credit supply activity.
As a banker to the government the central bank performs a variety of functions. It acts as a government agent in making payments and receiving money on its (the governmentís) behalf. It is in charge of supplying currency and maintaining fiduciary reserves and foreign exchange reserves. It is the only financial agency that can issue currency. It also has to control the rate of exchange of the currency in foreign trade and maintain the value of currency internally. It needs to provide financial and loan resources and maintain these accounts for the government. As a bankerís bank it acts exactly in the manner that commercial bankers act with their customers. It accepts deposits in the form of statutory reserves from banks. It rediscounts bankerís bills and provides financial assistance to them. It supervises and advises commercial bankers in various respects. Another fundamental function is to control credit created by commercial banks.
ii) The Federal Reserve Bank: The central bank of the U.S., the Federal Reserve Bank (or íFedí as it is usually referred to), is in charge of issuing all the currency of the country i.e. the Federal Reserve Notes. The commercial banks keep their share of bank reserves with the Fed. As the Fed is the clearing house i.e. the place where all the transactions between the banks can take place (say the clearing of checks), the commercial banks maintain a section of their required reserves with it.
Now consider the Balance Sheet of the Fed. Any Balance Sheet would list the Assets on the left side and the Liabilities on the right. The Assets section of the Balance Sheet of the Fed consists of a huge amount of government debt that is present in the form of U.S. government bonds. The U.S. Treasury issues these bonds in order to pay for the deficits of the present as well as past governments. Now the Liabilities section of the Balance Sheet of the Fed comprises of all the Federal Reserve Notes (U.S. currency) in circulation as well as all íreservesí held with the Fed, which are actually private bank deposits. An important thing to remember is that the Fedís total liabilities will always equal its total assets.
iii) Credit control: Commercial bankers are profit making agencies. For them creation and supply of credit is a source of profits. The total credit money supply is much in excess and a certain multiple of the cash deposits that they possess. Therefore commercial banks are likely to run into difficulties whenever their depositors suddenly increase demand for money. If the bankers are unable to satisfy the needs of their depositors then they are likely to fail and go bankrupt. But for the central bank it is a matter of prestige that every bank should operate successfully and come over its difficulties. Therefore the central bank keeps a severe control on the credit supply activities of the banks. In order to achieve its goals the central bank uses two devices. These are quantitative and qualitative methods of credit control.