Ever thought of how life would have looked like and existed if there were no central banks in a country? What if there was no medium of exchange? Well, the answer for it would be that there would not have been any modern form of currency like paper notes and coins. Moreover before the introduction of the coins, a variety of objects was used as money. For example, since the very early ages, Indians used grains and cattle’s as a source of money.
Central banks are an institution that manages the currency of the country and issues the currency notes on the behalf of the central government. The central banks controls the supply of money. The Reserve Bank of India is the central bank of India. Central Banks are also termed as “Lender of Last Resort” as it ensures that the commercial banks do not suffer any set-back and helps in providing them funds during their financial crisis.
As per the Indian law, no individual or an organisation other than Reserve Bank of India can issue currency. Hence, the currency is accepted as the medium of exchange as it is authorized by the government.
Here are the some of the most important functions of Central Banks -:
- Banker of the government – The central bank act as the Banker, Agent and Advisor to the government. It gives the government suggestions related to the economic and monetary policies and helps to manage the public debt of the country.
- Adoption of Minimum Reserve System – The Reserve Bank of India has adopted the Minimum Reserve System. This system gives the public, the trust that the Indian Government will pay them the face value of notes. The RBI has the right to issue the currency of several denominations except ONE RUPEE NOTE as it is issued by Ministry of Finance.
- Ensuring Stability of Foreign Exchange Rates – To ensure that the foreign exchanges rates are stable, the Reserve Bank of India buys and sells foreign currencies. RBI sells the foreign currencies in the foreign exchange market when its supply gets decrease. Therefore the foreign exchange reserve of India as of June 2024 is USD 655.817 billion.
- Helps in Development of Country – RBI helps in the development of the country. It helps in extending the banking services to semi urban and rural areas and also helps in establishment of institutions for agriculture credit or for providing funds.
- Supervises the Banking Institutions – The Reserve Bank of India supervises the functioning of formal sources of loans. For instance, we have seen that the banks maintain a minimum cash balance out of the deposits they receive. The RBI monitors the banks if they are actually maintaining cash balance or not.
- Custodian of Commercial Banks – The RBI sees that the commercial banks give loans not just to profit-making businesses and traders but also to small cultivators, small scale industries, to small borrowers etc. Periodically, all the commercial banks have to submit information to the RBI on how much they are lending, to whom, at what interest rate, etc.
Central banks have an impact on economy mainly in 2 ways – either functioning as a lender of last resort or regulating inflation and helping to control the price stability.
All the commercial banks provides loan to the public on the basis of first come first serve but if the commercial banks are short of funds, so in such a situation the commercial banks will approach to the Central Banks to borrow funds. Since the Central Bank hold the commercial bank reserves, so the Central Banks cannot favour any one bank. This is the reason that the RBI monitors on a regular basis whether the banks are maintaining minimum cash balance or not.
Since the Central Banks help to control the price stability in an economy, therefore Central Banks performs “Open Market Transactions”. Open Market Transaction System is a very important measure performed by the Central Banks as it helps to control inflation, money supply and prices. Open market transactions means buying and selling of securities or bonds without the involvement of any exchange of assets or funds. They perform the Open Market Transactions to absorb the extra funds which affect the inflation.
In India, the monetary policy is implemented by the central bank i.e. Reserve Bank of India. Monetary policy is an action that the central bank or the government can take to control nation’s overall money supply and help in promoting the economic growth. It protects the value of currency and also keeps the unemployment low. By manipulating interest rates or through open market operations, a central bank affects borrowing, spending and saving rates. The main aim of the monetary policy is to have price stability. The strategies of monetary policy includes revising of bank rates and changing bank reserve requirements.
But the fact that monetary policy are also of 2 types -: Contractionary and Expansionary.
A contractionary monetary policy increases interest rates and limits the outstanding money supply to slow growth and decrease inflation, where the prices of goods and services in an economy rise and reduce the purchasing power of money. On the other hand, during times of slowdown or a recession, an expansionary monetary policy grows economic activity. By lowering interest rates, saving becomes less attractive, and consumer spending and borrowing increase.
Therefore, the goals of monetary policy are as follows -:
- Inflation – Contractionary monetary policy is used to temper inflation and reduce the level of money circulating in the economy. Expansionary monetary policy fosters inflationary pressure and increases the amount of money in circulation.
- Unemployment – An expansionary monetary policy decreases unemployment as a higher money supply and attractive interest rates stimulate business activities and expansion of the job market.
- Exchange Rates – The exchange rates between domestic and foreign currencies can be affected by monetary policy. With an increase in the money supply, the domestic currency becomes cheaper than its foreign exchange.
Author – Samarth Mittal
DPS Yamunanagar
