CENTRAL BANKING

SUBMITTED TO:

Dr. SUBHASH SHARMA

SUBMITTED BY:

LUDARMANI

REGD. NO (F-15-04-M)

CENTRAL BANKING

CENTRAL BANK

According to De Kock “Central bank is a bank which constitute

apex of monetory and banking structure”.

Central banks were started as privately owned and privately managed

joint stock banks, but on account of their influence on economic

activities and their power to control credit, governments shows great

willingness to participate in the affairs of central banks.

DIFFERENCE BETWEEN COMMERCIAL

BANKS AND CENTRAL BANKCOMMERCIAL BANKS CENTRAL BANK

1.PROFIT MAKING IS FIRST CRITERIA. 1. CB THINKS ABOUT EFFECTS OF ITS

OPERATIONS ON WORKING OF ECONOMIC

SYSTEM.

CONSTITUTED FOR PROFIT MOTIVE. CONSTITUTED FOR PUBLIC SERVICES.

2.THESE MAY BE FEW OR MANY IN NUMBERS. 2.ONE IN EACH COUNTRY.

3. DEALS DIRECTLY WITH PUBLIC. 3.ACT AS BANKER’S BANK, DOES NOT DEAL

DIRECTLY WITH PUBLIC .

FUNCTIONS OF CENTRAL BANK According to De Kock functions of central bank are as :

1.BANK OF ISSUE :-

REGULATION OF CURRENCY IN ACCORDANCE WITH REQUIREMENTS OF BUSINESS

AND GENERAL PUBLIC.

2.BANK AND AGENT:-

PERFORMANCE OFGENERAL BANKING & AGENCY FOR THE STATE.

3.CUSTODY OF CASH RESERVES OF COMMERCIAL BANKS.

CENTRALISATION OF CASH RESERVES IN THE CENTRAL BANK IS THE SOURCE OF

GREAT STREANTH TO BANKING SYSTEM OF COUNTRY.

4.CUSTODIAN OF FOREIGN BALANCES:

CB CUSTODY THE NATION’S RESERVES OF INTERNATIONAL CURRENCY.

5.LENDER TO LAST RESORT:

GRANTING ACCOMODATION TO COMMERCIAL BANKS WHEN THERE IS CRISIS.

6.CLEARING HOUSE:

SETTLEMENT OF BALANCE BETWEEN BANKS.

CONTD…

7.CONTROLLER OF CREDIT:

CB ACT CONTROLLER OF CREDIT IN ACCORDANCE WITH NEEDS OF

BUSINESS AND WITH VIEW TO CARRYING OUT BROAD MONETORY POLICY

ADOPTED BY STATE.

ADVANCES SHORT TERM LOANS TO GOVERNMENTS TO TIDE OVER

DIFFICULTIES.

METHODS OF CREDIT CONTROL

1.QUANTITATIVE :-

INTEND TO CONTROL OF VOLUME OF CREDIT BY COMMERCIAL BANKS.

e.g., BANK RATE, OPEN MARKETING OPERATIONS.

2.QUALITATIVE/SELECTIVE CONTROL:-

INTEND TO CONTROL CERTAIN TYPE OF CREDIT.

e.g., REGULATION OF CONSUMER CREDIT etc.

BANK RATE

ALSO CALLED DISCOUNT RATE.

IT IS THE RATE PRESCRIBED BY CENTRAL BANK.

IT IS THE MINIMUM RATE AT WHICH CENTRAL BANK WILL DISCOUNT

FIRST CLASS BILLS OF EXCHANGE OR WILL ADVANCE LOANS AGAINST

APPROVED SECURITIES.

THERE IS DIRECT RELATION BETWEEN BANK RATE AND MONEY MARKET

INTERST RATES.

CHANGE IN BANK RATES ARE FOLLOWED BY CHANGE IN INTERST RATE

OF COMMERCIAL BANKS FOR SHORT TERM MONEY AND BANK LOANS

ADVANCES.

IT IS IMPORTANT INSTRUMENT OF CREDIT CONTROL.

CONTD… RISE IN BANK RATE CAUSES ADVERSE EFFECT ON BALANCE OF TRADE

AND ADVERSE BOT CAUSE EXPORT OF GOLD.

DUE TO INCREASE IN BANK RATE ALL OTHER MONEY RATES GOES UP.

FOREIGNERS, WHO OBTAIN HIGHER RATE ON THEIR INVESTMENT WILL

NOT DRAW MONEY.

THEIR WILL BE MOVEMENT OF CAPITAL INTO THE COUNTRY ON

ACCOUNT OF BETTER RETURN.

THE DEMAND FOR DOMESTIC CURRENCY WILL RISE, RAISING ITS

VALUE.

BORROWED FUNDS BECOMES COSTLY,LEADING TO DECLINE IN VOLUME

OF IMPORTS.

THE BALANCE OF TRADE BECOMES FAVOURABLE AS A RESULT IN BANK

RATE.

FOR SUCCESSFUL WORKING OF BANK RATE MECHANISM, MONEY

MARKET MUST BE INTEGRAL WHOLE i.e., CHANGE IN BANK RATE

SHOULD REFLEXIVE WITH MONEY MARKET RATE OF INTEREST.

CONTD… TWO DISTINCT VIEWS HAVE BEEN EXPRESSED BY HAWTREY AND KEYENES

REGARDING THE OPERATION OF RATE OF INTEREST AND INFLUENCE OF

INVESTMENT AND ECONOMIC ACTIVITY.

HAWTREY VIEW: MOVEMENT OF SHORT TERM RATE OF INTEREST AFFECT

INCOME,OUTPUT AND EMPLOYMENT THROUGH THEIR INFLUENCE ON

STOCK HOLDER.

`AS SHORT TERM RATE OF INTEREST GO UP, THEY WILL REDUCE STOCK

BECAUSE COST OF HOIDING HAS INCREASED.

KEYNESIAN VIEW:KEYNES EXPRESSED OPINION THAT THESE ARE MAINLY

INFLUENCED BY CHANGES IN LONG TERM RATE OF INTEREST.

INVESTMENT IN FIXED CAPITAL DEPENDS ON M.E.C. IN LONG RUN RATE

OF INTEREST.

OPEN MARKET OPERATIONS

PROF. HALM REMARKS, “IN VIEW OF SHORT COMINGS REDISCOUNT

POLICY THE DEVELOPMENT OF OPEN MARKETINGOPERATIONS- THE

PURCHASE AND SALE OF GOVT. SECURITIES AND OTHER CREDIT

INSTRUMENTS IN OPEN MARKET – AS AN ADDITIONAL AND TO SOME

EXTENT ALTERNATIVE INSTRUMENT OF CENTRAL BANKING POLICY IS

LOGICAL STEP.”

WHEN CENTRAL BANK WANTS TO REGULATE AMOUNT OF MONEY IN

CIRCULATION, IT RESORTS TO OMO, THE SALE AND PURCHASE OF

SECURITIES BY THE CB.

CONTD… IF THE CENTRAL BANK WISH TO DECREASE THE VOLUME OF CREDIT, IT

SELLS SECURITIES TO PUBLIC AND RECIEVES PAYMENT IN CASH OR

CHAQUES DRAWN ON COMMERCIAL BANKS.

IF THE CENTRAL BANK WANT TO INCREASE THE CREDIT, IT BUYS

SECURITIES FROM MARKET EITHER BY PAYING CASH DIRECT TO PUBLIC

OR BY CHEQUE.

OPEN MARKETING OPERATION IS IMPORTANT IN CREDIT CONTROL AND

PRODUCE THEIR EFFECT BY ALTERING CASH RESERVES OF COMMERCIAL

BANKS.

THEY ARE EXTREMELY FLEXIBLE BOTH IN AMOUNT AND TIMING.

AFFECT BANKING OPERATIONS WITH LEAST DISTURBANCE.

LIMITATIONS OF OPEN MARKETING OPERATION

METHOD OF CREDIT CONTROL OR CREDIT EXPANSION MAY NOT ALWAYS HOLD

TRUE.

FOR EXAMPLE, WHEN COMMERCIAL BANK FIND ADDITIONAL CASH THEY WILL

EXPAND CREDIT, WHENEVER THEY FIND THEIR CASH RESERVES

REDUCED,THEY WILL CONTRACT CREDIT.

ACTUALLY THIS DOES NOT HAPPEN.

CREDIT EXPANSION OR CREDIT CONTRATION IS MORE A MATTER OF BUSINESS

PSYCHOLOGY AND MOOD OF ENTREPRENERS.

OMO CAN NOT BE USED IN DEVELOPING COUNTRIES AS NECESSARY

CONDITIONS FOR SUCCESS DOES NOT EXIST HERE.

OMO BECOMES CHIEF INSTRUMENT OF CREDIT CONTROL IN COUNTRIES

WHERE MONEY MARKETS ARE WELL DEVELOPED.

BANK RATE VERSUS OPEN MARKET OPERATIONS THE USE OF BANK RATE & OMO CAN NOT BE SEPARATED FROM EACH OTHER,AS EACH BY

ITSELF MAY NOT BE AS EFFECTIVE AS DESIRABLE.

FOR EXAMPLE, IF OPEN MARKET POLICY IS NOT FOLLOWED BY SUITABLE CHANGES IN

BANK RATE, IT MAY PROVE INEFFECTIVE.

IF CB SELLS SECURITIES IN ORDER TO CONTROL CREDIT,BUT HAS NOT RAISED THE BANK

RATE , MEMBER BANKS WILL THEN REPLENISH THEIR RESERVES BY REDISCOUNTING THE

SECURITIES WITH CB BECAUSE THE BANK RATE IS LOW WHICH RENDER THE POLICY OF

CREDIT CONTROL UNSUCCESSFUL.

WHEN THE BANK RATE WILL RAISED ,REDISCOUNTING WOULD NOT HAVE BEEN POSSIBLE

& CREDIT CONTROL WOULD HAVE BEEN MORE EFFECTIVE.

ACC. TO PROF. HALM “ FROM THE STANDPOINT OF THEIR STRATEGIC VALUE TO CB, OPEN

MARKET OPERATIOS POSSESS A DEGREE OF SUPERIORITY OVER REDISCOUNT POLICY

BECAUSE OF THE FACT THAT INITIATIVE IN THE HANDS OF MONETORY AUTHORITY IN CASE

OF THE FORMER, WHILE BANK RATE POLICY IS PASSIVE IN THE SENSE THAT ITS

EFFECTIVENESS DEPENDS ON THE RESPONSES OF COMMERCIAL BANKS AND THEIR

CUSTOMERS TO CHANGE IN BANK RATES.

CONTD… OMO BECOMES SUPERIOR TO BANKRATE, BECAUSE THEY DIRECTLY

INCREASE OR DECREASE THE MONEY SUPPLY AND SHOW QUICKER AND

MORE DEFINITE RESULTS THAN BANK RATE CHANGES.

OMO ARE ALSO LESS HARMFULL THAN BANK RATE CHANGES AS THEY

AVOID THE DIFFICULTIES OF INTERNATIONAL FLOWS OF CAPITAL WHICH

TAKES PLACE DUE TO CHANGE IN BANK RATE.

BANK RATE AND OMO IN DEVELOPING

ECONOMIES

BANK RATE IN DEVELOPING ECONOMIES ASSUMES SIGNIFICANT ROLE

BECAUSE IT IS THE RATE AT WHICH PUBLIC CAN OBTAIN

ACCOMODATION FROM THE CENTRAL BANK,AT WHICH COMMERCIAL

BANKS OBTAIN ACCOMODATION FROM CENTRAL BANK.

EFFICIENCY OF OMO IS HIGHLY DOUBTFUL IN SUCH ECONOMIES

BECAUSE BASIC CONDITION FOR SUCCESS LIKE BROAD AND

EFFECTIVE SECURITY MARKET ARE NOT FULFILLED.

VOLUME OF SECURITIES IS VERY SMALL.

SELECTIVE CREDIT CONTROL

THE EFFECTIVENESS IS ON CERTAIN SPECIFIC TYPE OF CREDIT WHILE OTHER TYPE OF

CREDIT REMAINS MORE OR LESS UNAFFECTED.

IT SUITS TO DEVELOPING ECONOMY FOR THEY OFFER A WAY TO RESTRICT CREDIT

EXPANSION WHILE MAINTAINING LOW INTEREST.

SELECTIVE CONTROL MEASURESARE:

1.REGULATION OF CONSUMER CREDIT:-

THIS MEASURE TO C0NTROL CREDIT WAS ADOPTED FIRST IN USA IN 1941 TO KEEP

CONSUMPTION SPENDING AT LOW LEVEL.

IN THIS METHOD CB OF A COUNTRY IS AUTHORISED TO LAY DOWN TERMS AND

CONDITIONS FOR THE PROPER REGULATION OF CONSUMER CREDIT EXTENDED BY

COMMERCIAL BANK OF A COUNTRY.

THROUGH THIS METHOD, PURCHASE OF CONSUMER DURABLES IS REGULATED.

CONSUMER CREDIT REGULATION IS BASED ON THE OBSERVATION THAT MONETORY

DEMAND FOR CONSUMERS’ DURABLE GOOD IS EXTREMELY UNSTABLE AND IS OF

STRATEGIC IMPORTANCE TO GENERAL PRICE MOVEMENTS AND TO THE ECONOMIC

ACTIVITY IN THE ECONOMY.

2. MARGIN REQUIREMENTS

‘MARGIN’ REFERS TO THE DIFFERENCE BETWEEN MARKET VALUE OF

SECURITIES AND THE AMOUNT BORROWED AGAINST THESE SECURITIES.

FIRST TRIED IN USA IN 1934.

THE IMPORTANCE OF THIS METHOD IS THAT A BANK WHILE ADVANCING

CREDIT AGAINST A SECURITY DOES NOT LEND FULL AMOUNT BUT LESS.

IT IS DONE BY KEEPING A MARGIN BETWEEN VALUE OF SECURITY AND

AMOUNT OF ADVANCE TO COVER ANY POSSIBLE LOSS.

DURING INFLATIONARY BOOM BUSINESSMAN AND SPECULATORS TRY TO

GET CREDIT BY PLEDGING GOLD OR SECURITIES TO THE BANK.

3.MORAL PERSUATION

THROUGH THIS METHOD, CB OFTEN EXERT GREAT INFLUENCE OVER

THE LOAN POLICY OF MEMBER BANKS.

THERE IS CLOSE CO-OPERATION BETWEEN CB AND MEMBER BANKS.

MORAL PERSUATION IMPELLES IMFORMAL REQUEST BY CB TO

COMMERCIAL BANKS TO CONTRACT LOANS IN TIME OF EXPANSION AND

TO EXPAND CREDIT IN TIME OF DEPRESSION.

IT MAKE EASIER FOR CB TO SECURE THE WILLING AND ACTIVE CO

OPERATION OF MEMBER BANKS.

QUANTATIVE VERSUS QUALITATIVE

CREDIT CONTROL QUANTITATIVE CONTROL AIM AT REGULATION OF OVERALL VOLUME OF

BANK CREDIT.

SELECTIVE CONTROL MAY HAVE DIRECT IMPACT ON PERTICULAR SECTOR

OF ECONOMY.THEIR EFFECTIVENESS IS LIMITED.

WEAKNESS OF SELECTIVE CONTROLS IS THAT THEY DIRECTLY RESTRICT

INDIVISUAL CHOICE AMONG ALTERNATIVES.

MERIT OF SELECTIVE CREDIT CONTROL IS THAT DURING

INFLATION,QUATITATIVE CONTROLS ARE LIKELY TO PULL THE ECONOMY

DOWN TO DEPRESSION,IF APPLIED TOO SEVERELY.

FEAR OF SHORTAGE APPROACH LEAD MANY OBSERVERS TO PREFFER

SELECTIVE RESTRAINSTO CHECK INFLATIONARY LOANS.

THE SELECTIVE CONTROLS ARE A GOOD SUPPLEMENT TO QUANTITATIVE

CONTROLS.

CENTRAL BANKING IN AN UNDER-

DEVELOPED ECONOMY

IN UNDERDEVELOPED ECONOMIES CENTRAL BANKING INSTITUTIONS

ARE OF RECENT ORIGIN. “EVEN THOUGH RECENTLY ESTABLISHED,MOST

OF THEM ARE EQUIPED WITH LEGEL POWERS”.

EFFECTIVENESS OF CENTRAL BANKING IS VERY MUCH REDUCED ON

ACCOUNT OF A LARGE NON-MONETISED SECTOR,UNORGANISED MONEY

MARKET, UNDERDEVELOPED STOCKS AND SHARES, BONDS AND

SECURITIES MARKETS.

IN SUCH ECONOMY THE WEAPONS OF CREDIT CONTROL AND CREDIT

EXPANSION EITHER DO NOT WORK OR WORK WITH LOW EFFICIENCY.

INTEREST RATES ARE INSTITUTIONALLY DETERMINED AND, THEREFORE ,

CAN NOT BE VARIED BY CHANGES IN BANK RATE.

CONTD…

THE DEVELOPMENT OF COMMERCIAL BANK CAN BE ENCOURAGED

PARTLY BY PROVIDING CHEAP,LIBERAL AND LARGE SCALE RE-

DISCOUNTING FASCILITIES TO COMMERCIAL BANK AND PARTLY GIVING

SUBSIDY TO NEWLY STARTED BANKS.

THESE ECONOMIES HAS TO MAINTAIN INTEREST RATES AT REASONABLY

LOW LEVELS.

CB IN MOST OF UNDERDEVELOPED ECONOMIES HAVE HELPED

ESTABLISHMENT OF NEW COMMERCIAL BANKS ALONG WITH

DEVELOPMENT OF BRANCH BANKING.