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Central Bank — Functions and Role

Introduction to the central bank (RBI), its functions as currency authority, banker to government, banker's bank and supervisor, and custodian of foreign exchange reserves.

Notes

Central Bank — Functions and Role

Class 12 Macro Economics — RBI as the Apex Bank, Currency Authority, Banker to Government, and More

What is a Central Bank?

Central Bank
The 'Apex' body that controls, operates, regulates and directs the entire banking and monetary structure of the country.

It is called the apex (supreme) body because it holds the highest position in the country's monetary and banking system. Most financially developed countries have a central bank.

Central Banks Around the World

  • India: Reserve Bank of India (RBI) — established on April 1, 1935
  • UK: Bank of England
  • USA: Federal Reserve System

Currency Authority (Bank of Issue)

Currency Authority (Bank of Issue)
The Central Bank has the sole right to issue currency in the country. In India, the RBI has the sole right to issue paper currency notes (except one-rupee notes and coins, which are issued by the Ministry of Finance).

₹1 Note signed by

Finance Secretary

Other Notes signed by

RBI Governor

Currency is

RBI's Monetary Liability

Backed by

Gold, Securities, Forex

Advantages of Sole Authority of Note Issue with RBI

Monetizing the Government's Debt (Deficit Financing)

The Central Government can borrow from the Central Bank. When the government has a budget deficit, it borrows by selling treasury bills to the Central Bank. The Central Bank issues new currency when it buys these securities — this process is called 'Monetizing the Government's Debt' or 'Deficit Financing'.

Digital Rupee (CBDC)

  • RBI introduced a concept note on digital rupee in October 2022
  • First pilot for retail Digital Rupee (e₹-R) launched in December 2022
  • The digital rupee (e-rupee or Central Bank Digital Currency — CBDC) is an electronic version of physical cash
  • It is a legal tender issued by the central bank in electronic form
  • Aims to provide a more secure, government-backed alternative to private digital currencies
  • Advantages: efficient, quicker, and cheaper money transfers, faster settlements, lower transaction costs, and easier handling

Banker to the Government

The Central Bank acts as the government's banker, agent, and financial advisor.

As a Banker

  • •Manages government's banking business
  • •Maintaining accounts
  • •Accepting receipts
  • •Making payments
  • •Providing temporary loans/advances (e.g., against treasury bills)

As an Agent

  • •Manages public debt on behalf of the government

As a Financial Advisor

  • •Provides advice on economic, financial, and monetary matters

Banker's Bank and Supervisor

Supervisor Role

Regulates commercial banks regarding licensing, branch expansion, asset liquidity, management, mergers, winding up, etc. Control is exercised through periodic inspections and analysis of reports submitted by banks.

Advantages of Centralised Cash Reserves with Central Bank

  1. Ensures effective utilization of the country's total cash reserves
  2. Increases public confidence in the strength and stability of the banking system
  3. Enables the central bank to control commercial banks' credit creation by adjusting CRR
  4. Provides commercial banks with a source of financial assistance from the central bank during temporary difficulties

However, commercial banks may not favor this system as it reduces their liquid funds and the reserves held with the central bank typically do not earn interest.

Custodian of Foreign Exchange Reserves

Custodian of Foreign Exchange Reserves

The central bank holds the country's gold stock and foreign exchange reserves. This allows it to control foreign exchange transactions (which must be routed through RBI) and serves two objectives:

  1. Stabilizing the external value of the currency
  2. Implementing a coordinated policy regarding the country's balance of payments

Central Bank vs Commercial Bank

Central Bank vs Commercial Bank
AspectCentral BankCommercial Bank
MeaningApex body controlling the country's banking and monetary structureInstitution accepting deposits, granting loans, and making investments for profit
StatusApex institution in the money marketA unit operating under the central bank's control
OwnershipGenerally owned and governed by the governmentCan be owned by the government or the private sector
ObjectiveOperates in public interest without profit motiveAims to maximise profits
Issue of currencyHas sole monopoly in issuing currencyHas no power to issue currency
Public dealingDoes not deal directly with the publicDeals directly with the public
Number of BanksOnly one central bank in a country (e.g., RBI in India)Numerous commercial banks exist (e.g., SBI, PNB in India)