A central bank is the apex institution of a country's monetary and financial system. It plays a leading role in organising, running, supervising and regulating the activities of commercial banks and other financial institutions in the country. The design and conduct of monetary and credit policies are its special responsibilities. Hence, the central bank plays a very important role in the balanced development of a modem economy. The central bank occupies a pivotal position in the monetary and banking structure of every country. It is the highest monetary institution and a leader of the financial system of the country.
All developed and most of developing countries have a central bank. However, in most countries, the central bank is a 20th century financial institution. The Bank of England, the oldest central bank in the world, was set up in 1694 as a joint stock company by- an Act of Parliament. The Federal Reserve Bank in USA was established in 1913. In India, the Reserve Bank of India was set up on April 1st, 1935 under the Reserve Bank of India Act, 1934.
Functions of a Central Bank:
The different functions of the central bank are discussed in tune with the functions of RBI. They are as follows:
1. Issuer of Currency Notes: The Reserve Bank is the nation's sole note issuing authority. Along with the Government of India, the RBI is responsible for the design, production and overall management of the nation's currency, with the goal of ensuring an adequate supply of clean and genuine notes. The Government of India is the issuing authority of coins and supplies coins to the Reserve Bank on demand. The Reserve Bank puts the coins into circulation on behalf of the Central Government. In consultation with the Government of India, the RBI work towards maintaining confidence in the currency by constantly endeavouring to enhance integrity of banknotes through new design and security features.
2. Formulation of Monetary policy: Monetary policy refers to the use of monetary instruments under the control of the central bank to regulate magnitudes such as interest rates, money supply and availability of credit with a view to achieving the ultimate objective of economic policy. The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth. The Monetary Policy Committee (MPC) constituted by the Central Government under Section 45ZB determines the policy interest rate required to achieve the inflation target. The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy.
3. Banker and Debt Manager to Government: Managing the government's banking transactions is a key RBI role. Like individuals, businesses and banks, governments need a banker to carry out their financial transactions in an efficient and effective manner, including the raising of resources from the public. Since its inception, the Reserve Bank of India has undertaken the traditional central banking function of managing the government’s banking transactions. The Reserve Bank of India Act, 1934 requires the Central Government to entrust the Reserve Bank with all its money, remittance, exchange and banking transactions in India and the management of its public debt. The Government also deposits its cash balances with the Reserve Bank. The Reserve Bank may also, by agreement, act as the banker and debt manager to State Governments. Currently, the Reserve Bank acts as banker to all the State Governments in India (including Union Territory of Puducherry), except Sikkim. For Sikkim, it has limited agreement for management of its public debt.
4. Banker to Banks: Like individual consumers, businesses and organisation of all kinds, banks need their own mechanism to transfer funds and settle inter-bank transaction-such as borrowing from and lending to other banks-and customer transactions. As the banker to banks, the Reserve Bank fulfills this role. Banks are required to maintain a portion of their demand and time liabilities as cash reserves with the Reserve Bank. For this purpose, they need to maintain accounts with the Reserve Bank. They also need to keep accounts with the Reserve Bank for settling inter-bank obligations, such as, clearing transactions of individual bank customers who have their accounts with different banks or clearing money market transactions between two banks, buying and selling securities and foreign currencies.
5. Regulation of the Commercial, Cooperative and Non-Banking Financial Institutions: The Reserve Bank is striving towards a more competitive, efficient and heterogeneous banking structure. It believes that a heterogeneous banking system can meet varied customer needs in a more efficient manner. Regulation of the commercial banks aimed at protecting depositors’ interests, orderly development and conduct of banking operations and fostering of the overall health of the banking system and financial stability. The Reserve Bank acts in close co-ordination with other regulators, such as, Registrar of Co-operative Societies and Central Registrar of Co-operative Societies. This role as regulator of Non-banking financial institutions is, perhaps, the most unheralded aspect of its activities, yet it remains among the most critical. This includes ensuring credit availability to the productive sectors of the economy, establishing institutions designed to build the country’s financial infrastructure, expanding access to affordable financial services and promoting financial education and literacy.
6. Regulator of the Financial Market and Foreign Exchange Management: In order to ensure the robustness and credibility of the financial system and to minimize the risks, the Reserve Bank has designated industry bodies Fixed Income, Money Markets and Derivatives Association of India (FIMMDA) and Foreign Exchange Dealers Association of India (FEDAI) as the benchmark administrators for the Rupee interest rate and foreign exchange benchmarks, respectively. With the transition to a market-based system for determining the external value of the Indian rupee the foreign exchange market in India gained importance in the early reform period. FEMA aims at facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange markets in India. Emphasizing the shift in focus, the Reserve Bank in due course also amended (since January 31, 2004) the name of its department dealing with the foreign exchange transactions to Foreign Exchange Department from Exchange Control Department.
7. Financial Inclusion and Development: This role encapsulates the essence of renewed national focus on Financial Inclusion, promoting financial education and literacy and making credit available to productive sectors of the economy including the rural and MSME sector. The Indian economy has changed since priority sector lending guidelines were conceived. There is a need to reorient guidelines towards today’s growth and inclusion agenda. As such, an Internal Working Group was constituted by the Reserve Bank with the objective of revisiting the existing priority sector lending guidelines and suggesting revised guidelines in alignment with the national priorities as well as financial inclusion goals of the country.
8. Research and Data: The Reserve Bank has a rich tradition of generating sound, policy-oriented economic research, data compilation and knowledge-sharing. The Reserve Bank has the legal obligation under the Reserve Bank of India Act to publish two reports every year: the Annual Report and the Report on Trend and Progress of Banking in India. Besides these and the regular periodical publications, it also publishes reports of various committees appointed to look into specific subjects, and discussion papers prepared by its internal experts.
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