A central bank is an important institution for many different countries. With the responsibility of managing a country’s money supply, a central bank works to provide stability to the economy of it’s country.
A central bank is owned by the respective country’s government. However, in order to make sure that political decisions do not influence its practices, a central bank is kept separate from the country’s ministry of finance. With precursors dating back to medieval Europe and China, central banks have become commonplace in many different countries. Some common examples include the Federal Reserve (USA), The Bank of England, Reserve Bank of Australia, European Central Bank, and Central Bank of the United Arab Emirates (for a full list of central banks, go here: http://www.bis.org/cbanks.htm)
A central bank has a few primary functions. While not all central banks have exactly the same functions (as it is determined by that country’s individual government) many of them share the following.
The first function is to establish the monetary policy of the country. In most cases this means the establishment of a currency, which includes the type of currency and how it will be backed.
With the establishment of the monetary policy, one primary concern of the central bank is the regulation of the level of inflation in a country. One of the ways that inflation is regulated is through controlling the amount of money that is in circulation. For example, if a central bank increases the amount of money that is in circulation (usually done through the buying of government issued notes, such as bonds or bills), interest rates for borrowing usually drop yet inflation usually rises. If a central bank sells those same government notes, interest rates usually rise and inflation rates drop. All of these transactions are done through open market transactions and allow the central bank to control money supply, price stability, and inflation.
Another important role of the central bank can be to regulate and supervise the commercial banking industry of its country. This can include anything from examining policies toward customers, keeping an eye over any potential bank mergers or possible cartels, and examining balance sheets.
Finally, a central bank is often referred to as the “lender of last resort.” In the case when a commercial bank does not have enough money in reserve to cover its promises (such as loans), a commercial bank can borrow money from the central bank. This allows the commercial bank to stay open and reduce the panic that can happen when a bank fails.
A central bank is an important part of a country’s financial life. By fulfilling its responsibilities, it can help keep a country financially stable and healthy.