Roles and Objectives of Central Banks

Currency Regulation

The central banks have the monopoly of notes issue, and these notes issued by central banks act as legal tender of money. Each central bank has an issue department that issues coins and notes to commercial banks. Even though these notes and coins are manufactured by the government, they are put into circulation by the central bank. Therefore, the money put in circulation must be monitored to ensure that there is just the right amount in circulation.

Control of Commercial Banks

All commercial banks are under obligation to prepare and submit a report of their undertaking to the central bank after a given period of time. These statistics are important in decision-making in the finance sector. The central bank can influence the activities of the commercial banks through its monetary policies.

Banker, Fiscal Agent and Adviser to the Government

The central bank receives deposits on behalf of the government from sources like income tax and foreign aid. It also makes payments on behalf of the government. Moreover, the central bank gives advice to the government on economic and monetary matters such as inflation and deficit financing. The government also gets short-term loans from it the central bank.

Controller of Credit

The control of credit is realized through the use of monetary policy. The central bank controls the credit creation power of commercial banks to curb inflationary and deflationary pressures in the economy.

Custodian of Cash Reserves of Commercial Banks

The law requires that commercial banks keep reserves to a particular percentage with the central bank. It is on this basis that the central bank transfers money from one bank to another to facilitate the clearing of cheques. A central bank is, therefore, a bank to commercial banks.

Lender of Last Resort

Commercial banks normally borrow from discount houses. However, during times of financial problems, commercial banks can seek funds from the central bank by borrowing at the market rate instead of the bank rates given by discount houses.

Objectives of Central Banks

The main objective performed by a central bank is ensuring financial stability. Depending on the country, central banks might have other objectives such as controlling inflation, unemployment, interest rates, or exchanges rates. However, all of these are in line with the main objective of ensuring financial stability.

Question

Explain the term credit control as a function of the central bank. Credit control refers to actions undertaken by central banks in:

A. Lending funds to commercial banks during financial problems at market rates.

B. Controlling the amount of money in the economy.

C.  Controlling the credit creation power of commercial banks.

Solution

The correct answer is C.

The central bank controls the credit creation process by commercial banks so as to control inflationary and deflationary pressures on the economy.

Reading 18 LOS 18f:

describe roles and objectives of central banks

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