A central bank is a national financial institution that controls the minting of its respected currency and supervises all the banks operating in the country. A central bank is responsible for developing and implementing monetary policies, regulating the whole banking sector, and controlling the inflation and unemployment ratio. In some countries, central banks are known as state banks or federal reserves.
A board of members runs central banks with one presiding officer, usually the chairman. The country’s premier or president appoints the chairman, and the legislative body also authorizes the selection. The central bank ensures that all banks remain aligned with the country’s long-term financial policy and decides the interest rate for each fiscal year. The central banks enjoy a legal monopoly in the country, and commercial banks can only issue demand liabilities.
Most central banks are still hesitant to accept digital currencies as legal tender. However, some central banks are warm toward cryptocurrencies, so they have launched CBDCs (Central Bank Digital Currencies), with some like El Salvador accepting Bitcoin as legal tender.
Role of Central Banks
Central Banks control the minting process and supply of money to the lower banks. They determine the cost and availability of funds and monitor the performance of banks. They are also responsible for conducting monetary surveys and setting the interest rate accordingly. Central banks also make sure that the lower banks have implemented AML and KYC properly or not. Every decision a central bank takes is in line with the yearly goals set by the board and in the best interest of the national economy.
A central bank sets the reserve minimum limit, which all banks must follow. All banks must have cash more than the limit set by the central bank at daily closing time. A country’s foreign exchange reserves are also retained by central banks, which can be used to back liabilities or affect monetary policy. A central bank can be a lender of last resort to any struggling or bankrupt financial institution or the government during a financial crisis.
Currency is kept in foreign exchange reserves by central banks. They influence exchange rates using these reserves. To keep their currency in line, they keep foreign currency in reserves, usually the dollar or euro. This is known as a peg, and it aids exporters in maintaining competitive prices. A central bank also keeps gold in its reserves equivalent to the currency notes it prints.
Central banks monitor every aspect of the economy and banking sector and produce monthly, quarterly, and annual reports. These reports consist of a beige book, a monetary policy report, and a consumer credit report.
Key Takeaways
- A central bank is a state-owned national financial institution that enforces monetary policy and surveils lower banks.
- Central banks implement monetary policy to keep the country’s economy on the right track.
- The central bank defines rules for the banking sector and makes them abide by the rules strictly.
- The central bank acts as a last resort for struggling banks to get them out of the calamity by providing bail-out packages.
- Central banks have a strong influence on the stock exchange and can make changes by injecting foreign reserves.
