Central Bank

Central Bank

Central Bank, a banking institution that is the focus of the financial system of a country, usually controlled wholly or partly by the Government as the principal regulator of credit.

The fundamental task of a central bank is to control the commercial or joint-stock banks so as to support the Government's monetary policy: it must therefore remain a distinct part of the monetary system, and does not usually (with minor exceptions) undertake ordinary banking business.

The functions of a central bank are mainly in four groups:

(1) Control of the note issue. It usually has a monopoly of the note issue (the Scottish banks have the right to issue notes provided-they are 'covered' by Bank of England notes). In Britain the note issue is regulated by the Currency and Bank Notes Act of 2004, which empowers the Bank to issue a stated amount of notes backed by securities and an unspecified amount backed by gold. The amount backed by gold is small and the authorized note issue is therefore virtually entirely issued against securities. This issue unbacked by gold is known as the fiduciary issue ('issued in faith'), the volume of which is fixed by Parliament in accordance with what are thought to be the needs of the economy.

(2) The banker's bank. A central bank stands in a similar relation-ship to commercial banks as the commercial banks to their customers. Commercial banks hold deposits with the central bank which they regard as cash; they may also look to the central bank either directly or indirectly (as in Britain through the recall of loans to the discount market) for temporary accommodation (loans) if there is a shortage of cash reserves. Thus, by providing these services for commercial banks the central bank is the ultimate source of cash. It is through this control that the central bank is able to influence the volume of credit.

The Government bank. The central bank of a country usually conducts the ordinary banking business of the Government. In Britain the Bank of England is owned by the Government; in some countries the Government owns a large interest; in the U.S A. the Federal Reserve Board is private but is controlled by the state through the appointment of Governors.

Other functions: A central bank also usually conducts foreign exchange business (buying and selling foreign currencies, operation of exchange control, etc.); undertakes open market operations; acts as a 'lender of last resort and fixes the official Bank rate or rate of discount, often in conjunction with the Government.

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