Rise of American Accounts. "Hollywood ".

MAIN FUNCTIONS OF A CENTRAL BANK

1.Bank of Issue

2.Banker,Agent and Advisor to the Government

3.Custodian of the Cash Reserve of the Commercial Banks

4.Custodian of Nation's Foreign Exchange Reserve

5.Lender of the Last Resort

6.Bank of Central Clearance, Settlement and Transfer

7.Miscellaneous Functions

4.Custodian of nation's foreign exchange reserve. This function of the central bank is derived from functions of (1) note issue (2) custodian of cash reserves of commercial banks. As custodian of foreign exchange reserves, the central bank tries to manage it judiciously to overcome the difficulties of balance of payments. Its aim is to maintain reasonable stability in the exchange rates. Increasing exchange control measures especially in the developing countries have enhanced the responsibility and importance central banks as the custodian of foreign exchange reserves.

5.Lender of the last resort. In present times, the function of the 'lender of the last reaper's is treated as the sine quo non of central banking. This function of the central bank emerged slowly over a period of time mainly because of -

(1) its monopoly over notes issue.

(2) centralisation of metallic and cash, reserves, and

(3) its greater capacity to create credit.

The first one to recognise this important function of the central bank was Walter Bagehot, who is 1873, virtually pleaded that the Bank of England (i.e.Central Bank of England) should assume this role. He wrote in his book 'Lombard Street ' "Theory suggests, and experience proves, that in a panic the holders of the ultimate bank reserves (whether one bank or many) should lend to all that bring good securities quickly, freely and readily. By that policy they allay a panic: by every other policy they intensify it. The public have a right to know whether the Bank of England -the holders of our ultimate bank reserves-acknowledge this duty, and are ready to perform it. " He further pleaded that as a bank keeping the banking reserves of the country, "...it must in time of panic do what all other similar banks must do : that in time of panic it must advance freely and vigorously to the public out of the reserves. "

The central bank performs this function by extending the rediscounting facility to the banks, which enhances the elasticity and liquidity of the entire banking system.

6. Bank of central clearance, settlement and transfer. As banker's bank and the custodian of cash reserves of commercial banks, the central bank can conveniently perform another important function, i.e., as a bank of central clearance, settlement and transfer. As all the banks in a country have accounts with its central bank, it can easily settle their mutual claims through mere book keeping entries. It provides "an expeditious and economical machinery for the clearance of drafts and settlement of internal accounts. " As the claims are settled through transfer entries actual currency and coins are not used. Thus, the wear and tear of currency is avoided. The centralised clearing saves labour. It is much more expeditious and convenient as compared to individual clearings i.e. direct clearing between two banks. The economy in the use of money due to this function of the central bank and the resultant increase in the liquidity of the banking system was recognised by H. P. Willis in the following words : "It is not only a means of economising cash and capital, but is also a means of testing at any time the degree of liquidity which the community is maintaining - a matter which is essential for the central bank to know from day to day ".It may be added here that it is essential for the central bank to know liquidity with the commercial banks as it will enable it to control credit in the economy more effectively.

The clearing function has become a necessary service to be rendered by the central bank. L. C. Jauncey has recognised clearing as "the main operation of central banking. "

7. Controller of credit. Controlling the credit has emerged as the most important function of all central banks today. The principles and importance of credit control were recognised by Bagehot way back in 1873. However, its significance was recognised by all after the First World War in the face of economic fluctuations.

In the modern economies credit has become more important than the actual currency. It is the dominant constituent of the total money supply. Uncontrolled credit can play havoc with the economy. It can cause wide fluctuations in the purchasing power of value of money - which in turn has the potential of creating economic and social unrest. At times the commercial banks because of the money market conditions may be reluctant to meet even the genuine and desired credit needs of industry, trade and commerce. This will hinder the economic growth of the country. In such a situation the central bank has to step in to encourage the credit creation. In contrast when the commercial banks are extending too much credit, which may be flowing into the unwanted channels, the central bank checks the credit in the economy.

According to De Kock, "It is the function which embraces the most important questions of central banking policy and the one through which practically all other functions are united and made to serve a common purpose. " It is this function which integrates the other central banking functions like note issue, custody of the cash reserves, lender of the last resort, etc. to achieve the effective control over credit. So important and crucial this function is that the statutes of central banks of various countries recognise it as a main function of the central bank. Our own Reserve Bank of India Act 1934 states that RBI is "generally to operate the currency and credit system of the country to its advantage. "

To these functions we can add another category covering the residuary functions under the heading :

8.Miscellaneous functions. In addition to the aforementioned functions, central banks of almost of all the countries perform certain miscellaneous functions. For example, maintaining relations with international financial institutions like the I. M. F. and World Bank, etc. In fact, maintaining relations with these institutions through some centralised agency led to the establishment of central banks in many countries. In the interest of international liquidity and economic growth of the country it becomes essential for the developing countries to maintain relations with these institution and international development agencies.

The central bank also conducts economic surveys. It conducts seminars and publishes various types of vital reports. At times it may be extending the staff training facilities to the personnel of commercial banks. The central bank also collect data. The data is published regularly for the use of bankers, government and researchers.

From the aforegoing discussion it is clear the central bank performs these functions without any profit motive and it is the general public interest which is supreme for it.

CENTRAL BANK IN DEVELOPING ECONOMIES

The central bank has to play a different kind of role in under-developed economies or a developing economy like India. In addition to the traditional functions it has to perform many development functions. The central bank performs the following functions :

1.Direct dealings with public. General direct dealing with public by the Central bank is not favoured. Dealing with public is left to commercial banks. However, in some underdeveloped economies commercial banking system may not be sufficiently developed. In such cases to encourage the banking habits among the people, which is necessary for economic growth, the central bank may have to perform the commercial banking functions in addition to central banking functions.

2.Development of integrated viable commercial banking system. A viable commercial banking system is almost a pre-requisite for development. As leader of the banking system, the responsibility for developing an integrated viable commercial banking system falls on the central bank. This can, to some extent, be achieved by providing cheap and easy rediscounting facility to commercial banks. Till a viable commercial banking system emerges, the central bank has to continuously support and protect the commercial banks through all possible means, e. g. providing deposit insurance, etc.

3.Providing training to manpower. In the initial stages of economic development one of the difficulties faced by the commercial banks is the lack of trained manpower. Sometimes due to financial constraints it may not be possible for the individual commercial banks to establish their own training colleges. In such cases the central bank should provide the training facilities to the staff of the commercial banks.

4.Monetary expansion. Economic development without adequate monetary expansion is not possible. Monetary expansion becomes a necessity to meet the needs of growing economic activity. Thus the central bank has to ensure adequate monetary expansion without adversely affecting the price stability.

5.Establishment of term lending institutions. Commercial banks especially in developing countries cannot meet all types of credit requirements. To ensure rapid growth of various sectors of the economy like industry, agriculture and foreign trade, establishment of specialised financial institutions becomes necessary. These non-banking financial institutions extend term loans to the concerned sectors of the economy.

6.Proper branch expansion. Under-developed economies are usually agriculture oriented and unless the credit facilities are extended to agriculture and farm sector, it is not possible to get out of the trap of under-development. However, in all economies there is a tendency on the part of commercial banks to concentrate the branch expansion to urban and semi - urban areas only. So to extend banking to rural areas, the central bank is expected to regulate and formulate branch expansion programmes.

7.Ensuring balanced regional growth. The fruits of development should not be concentrated to privileged regions. This can cause social and political unrest also. To ensure the balanced regional growth, central banks are expected to formulate suitable policies. Special benefits can be extended to backward areas. Similarly, the benefits of banking development can be extended to rural areas. For example, in India a number of regional rural banks have been established.

8.Controlling Prices. In developing economies the central bank has to carefully regulate the money supply in the economy. An excess of money supply may lead to a sharp rise in prices, which may disturb economic and social balances in the economy.

However, playing the promotional role effectively is not an easy task for the central bank. The difficulties which it faces in performance of development functions are following :

(a) Undeveloped money market and capital market.

(b) Undeveloped commercial banking.

(c) Existence of unorganised banking sector.

(d) Existence of non-monetised sector, etc.

CREDIT CONTROL

It has been stated earlier that controlling credit has emerged as the most important function of all control banks today. It is the most important function as it integrates the other central banking functions. Now, we are turning attention to various aspects of this important function.

If business and credit conditions could be maintained in perfect stability, the central banking functions will be greatly simplified. The central bank will be required to provide necessary elasticity in the credit supply and accommodate industry, trade and commerce. However, business and credit conditions are never stable and central banks are charged with the delicate and complex duties of credit control.

With the emergence of modern 'planned economies ' the objectives and techniques of credit control have diversified. Now it is realised that appropriate control over credit is essential to prevent money, which is a good servant, from becoming at times a bad master.

Despite the general agreement amongst economists on the point that credit should be controlled in order to avoid fluctuations in prices and maladjustments in the national economy, there has been a divergence of opinion regarding the main objectives of credit control.

OBJECTIVES OF CREDIT CONTROL

The objectives of credit control are many, but a few basic ones, which are always a matter of concern, are discussed below :

1.Exchange Stability. The earlier objective of proper credit control was to maintain exchange rate stability. In fact, international gold standard was maintained for this purpose from 1875 to 1914. However, during World War 1 it was given up. It was revived again during the period 1925 to 1936. Why was exchange stability given so much of importance? This was due to the belief that for international prestige and smooth flow of international trade, exchange stability is a precondition. However, it was experienced that the quest for exchange stability was causing fluctuations in the domestic prices. Thus, after the breakdown of international gold standard, price stability as the objective of credit policy drew more attention.

2.Price Stability. The experiences of the Great Depression of the 1930s brought a realisation amongst the economists that maintaining exchange rate stability at the cost of domestic price stability was not desirable. The opinion earlier expressed by I. Fischer that price stabilisation is the ultimate end of central banking policy was accepted by more and more economists. It was understood that the price changes bring economic dislocation and loss of economic welfare and ultimately affect the social, political and moral structure of society. The viewpoint that price stability should be preferred to exchange stability in case of the incompatibility of the two gained more and more support.

Domestic stability need not be sacrificed in quest of international stability. In fact, exchange rate cannot be stable in the face of world wide price fluctuations. Similarly, no country can achieve domestic price stability by permitting fluctuations in the exchange rate, Truly speaking, credit control involves co-ordination of international features with domestic objectives. If international financial relations remain stable, domestic prices will also stabilise.

3.Economic stability and growth. Price stability does not mean economic stability or economic growth. Many economists have recognised the economic growth and economic stability as the main objectives of credit policy. The objective of credit control should be to bring stability to all economic variables besides price stability. It may be clarified that stability should not be confused with rigidity. Credit control should ensure that cyclical fluctuations are avoided and there is unhindered economic growth.

4.Maximisation of employment. The great depression of 1930s made the bankers, economist and politicians realise the importance of full employment or maintaining maximum employment. Unemployment is economically wasteful and socially undesirable. Thus, in recent times emphasis has been on economic stability compatible with full employment and high per capita income. The goal is so important that a number of countries have declared it to be one of the main objectives of the economic policy.

5.Stabilisation of the money market. Another objective of the credit policy is to provide for limited stabilisation of the money market so as to minimise the interest rate fluctuations due to temporary factors. The aim is to inject enough credit into the market or to take out enough credit to counterbalance the effect of temporary fluctuations. However, this objective is accorded only limited importance as compared to others. In fact, to achieve other objectives it may become necessary to destablise short run interest rates.

In the end, to quote De Kock, "the opinion of the monetary experts is to combine the objectives of international exchange stability with high levels of employment and real income.