What is central bank? Explain its functions. [2+8]

Central Bank

A central bank is the apex financial institution of a country that controls and regulates the monetary policy, banking operations, and financial stability of the nation. It acts as the banker’s bank, the government’s bank, and the controller of credit in the economy. Unlike commercial banks, which operate for profit, the central bank operates as a public institution with the primary objective of promoting economic stability, controlling inflation, and ensuring financial system integrity.

In Nepal, the Nepal Rastra Bank (NRB) serves as the central bank, established under the Nepal Rastra Bank Act, 2058 (2002). It is responsible for issuing currency, managing foreign exchange reserves, and implementing monetary policies to achieve macroeconomic stability.

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Functions of the Central Bank

The central bank performs various functions, which can be broadly categorized into primary and secondary functions.

1. Primary Functions

These are the core functions that define the role of a central bank in the economy.

a) Issuance of Currency

• The central bank has the monopoly right to issue currency notes and coins in the country.
• In Nepal, the Nepal Rastra Bank (NRB) is the sole authority to print and circulate currency.
• It ensures that the supply of money in the economy is adequate but not excessive to prevent inflation or deflation.
• The central bank maintains currency reserves (gold, foreign exchange) to back the issued currency and ensure its convertibility and stability.

b) Banker to the Government

• The central bank acts as the financial agent of the government, managing its accounts.
• It transacts government business, including:
  • Receiving and disbursing government funds.
  • Managing public debt (issuing government securities like bonds and treasury bills).
  • Providing short-term loans to the government (called ways and means advances) to meet temporary cash shortages.
• It also advises the government on economic and financial matters.

c) Banker’s Bank

• The central bank provides banking services to commercial banks, including:
  • Keeping reserves of commercial banks (required reserves and excess reserves).
  • Lending money to commercial banks in times of liquidity crisis (through rediscounting and repo operations).
  • Clearing and settling interbank transactions (e.g., cheque clearing).
  • Acting as a lender of last resort to prevent bank failures.

d) Controller of Credit

• The central bank regulates the supply of money and credit in the economy to achieve price stability, full employment, and economic growth.
• It uses monetary policy tools such as:
  • Bank Rate Policy (interest rate at which the central bank lends to commercial banks).
  • Open Market Operations (buying/selling government securities to adjust money supply).
  • Cash Reserve Ratio (CRR) (percentage of deposits that banks must keep with the central bank).
  • Statutory Liquidity Ratio (SLR) (percentage of deposits that banks must invest in approved securities).
  • Repo Rate and Reverse Repo Rate (short-term borrowing/lending rates for banks).

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2. Secondary Functions

These functions support the primary objectives of economic stability and development.

a) Custodian of Foreign Exchange Reserves

• The central bank holds and manages the country’s foreign exchange reserves (foreign currencies, gold, SDRs).
• It intervenes in the foreign exchange market to stabilize the exchange rate of the national currency (e.g., Nepalese Rupee).
• In Nepal, NRB maintains reserves to ensure external stability and confidence in the currency.

b) Supervision and Regulation of Banks

• The central bank licenses, supervises, and regulates commercial banks and financial institutions.
• It ensures sound banking practices to prevent bank failures and financial crises.
• In Nepal, NRB conducts periodic inspections, enforces prudential norms, and takes corrective actions if needed.

c) Promoter of Economic Development

• The central bank supports economic development by:
  • Providing refinance facilities to priority sectors (agriculture, industry, exports).
  • Encouraging financial inclusion (e.g., promoting microfinance and digital banking).
  • Conducting economic research and providing economic data for policy-making.

d) Management of Public Debt

• The central bank manages the government’s debt portfolio, including:
  • Issuing government securities (bonds, treasury bills).
  • Advising on debt management strategies.
  • Ensuring transparency and efficiency in debt operations.

e) Acting as a Clearing House

• The central bank facilitates the clearing of cheques and bills between banks.
• It ensures smooth and efficient settlement of interbank transactions.

f) Providing Economic and Financial Advice

• The central bank advises the government on economic policies, inflation control, and financial stability.
• It publishes economic reports (e.g., Annual Report, Monetary Policy Review) to guide policymakers and the public.

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Importance of the Central Bank

1. Monetary Stability: Ensures price stability by controlling inflation/deflation.
2. Financial System Stability: Prevents bank runs and financial crises.
3. Economic Growth: Supports investment and development through credit control.
4. Confidence in Currency: Maintains trust in the national currency through proper management.
5. Government Support: Helps the government in fiscal operations and debt management.

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Conclusion

The central bank plays a pivotal role in the economy by performing primary and secondary functions that ensure monetary stability, financial system integrity, and economic growth. In Nepal, the Nepal Rastra Bank (NRB) fulfills these roles to maintain price stability, employment, and sustainable economic development. Its independent yet accountable nature ensures that it can effectively implement monetary policies without political interference, thereby contributing to the overall welfare of the nation.