Basic of Central Banks
Central banks are the apex financial institutions of their respective countries. In some countries, central banks are known as Reserve Banks. In addition to overseeing the commercial banking system in a country, a central bank is also in charge of printing of a nation’s legal tender as well as exerting monetary policy controls on a nation’s economy. Examples of central banks are the Federal Reserve Bank (US), the European Central Bank (ECB), the Bank of Canada (BoC), the Bank of Japan (BoJ) and several others. Every nation in the world has a central bank.
Generally speaking, a central bank has a head, known as the Governor or the Chairman, and a board of governors. They are responsible for the management of the bank. A central bank will also have several departments which are in charge of the various functions of the bank. So a central bank will have a division that conducts banking supervision and regulation of banks, another division for currency operations (printing, circulation and money supply controls), and another division for carrying out monetary policy functions. The exact structure of a central bank will differ from one country to another, according to the peculiarities of each nation’s financial sector.
Monetary policy is the primary task of any central bank. Monetary policy refers to issues such as determining what currency a country will have, whether that currency will have a fixed or floating exchange rate, issues pertaining to determination of interest rates and foreign reserve maintenance policies. The central bank is also in charge of printing and circulation of a nation’s legal tender, as well as the control of the supply of a nation’s currency. A central bank is also in charge of maintaining a country’s foreign reserves, and in determining what currency a nation will hold reserves in.
Stability of a nation’s financial system is another function of the central bank. In this role, a central bank becomes a lender of last resort. We saw this function exerted by the Federal Reserve Bank in the US in providing $700 billion bailout for the US banking and automobile sector under the Troubled Assets Relief Program (TARP) following the collapse of several banks in the US during the global financial meltdown of 2008.
Central banks provide emergency lending to commercial banks by providing a lending window at the interest rate it has determined. This is another way of functioning as a banker of last resort.
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