Central Banking

Functions and Credit Control

Prof. Hanumant Yadav

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Central Banking : Meaning
 Central Banking is a banking system in which an
Apex bank as a Government bank controls and
stabilizes the entire monetary and banking
activities of the country.
 Central Bank is government established agency
responsible for controlling the nation’s money
supply and credit conditions and for supervising
the financial system, especially commercial banks
and other depository institutions.

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Objectives of Central Banking
1. Issue and Regulation of Currency
2. Handling of Governments monetary transactions
3. Strengthening of Banking system of the country
4. Custody and Management of Foreign Exchange
Reserves
5. Economic development

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Functions of Central Bank
1. Issue and regulation of Currency
2. Banker, Fiscal Agent and Adviser to the
Government
3. Banker’s Bank
4. Custody and Management of Foreign Exchange
Reserves
5. Lender of the last resort
6. Clearing House for transfer and settlement of
mutual claims of banks.
7. Controller of Credit
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Detailed Functions of Central bank
Bank of Issue :
The Central Banks in all the countries have been
given the sole right of note- issue. The right of
note-issue is regulated by Law.
Banker, Agent and Advisor to the Government
The Central Bank as Banker to the Government renders all
those services which a bank ordinarily performs for its
customers. It acts
as advisor to the government on matters of economic
policies like deficit financing, foreign exchange policy,
trade policy, etc.
As an agent Central Bank undertakes the sale and purchase
of government securities.
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Functions of Central Bank
Banker’s Bank :
The Central Bank functions as bankers bank, provides
rediscounting facilities and acts as custodian of the cash
reserves of the commercial banks.
Management of foreign exchange reserves
The Central bank functions as the custodian of nation’s
reserves of foreign exchange and responsible for
maintaining the external value of currency.

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Functions of Central bank
LENDER OF LAST RESORT :
It meets all reasonable financial requirements of
the commercial banks in times of financial need.
Bank of Central Clearance, Settlement and
Transfer :
Since banks keep cash reserves with the Central Bank
hence the claims of the banks against one another is easily
settled and conveniently transfered from and to their
account

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Credit Creation
The Central Bank creates credit by advancing
loans to Government and banks.
As a matter of fact entire banking system creates
credit. Credit creation depends on the number and
quantity of its deposits.
Method of Credit Creation :
1-Granting of loans,
2-Overdraft facilities,
3- Discounting of bills,
4- Purchase of government bonds and
securities.
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Credit Control
 Credit Control means controlling the lending policy
of commercial banks by the Central Bank.
 Central Bank adopts quantitative and qualitative
methods to control credit
 Quantitative methods aim at controlling the cost
and quantity of credit,
 Qualitative method aim at controlling the use and
direction of credit.

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Objectives of Credit Control

1. Stabilization of Internal Price level

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Methods of Credit Control
1. General or Qualitative Credit Control
General or Quantitative methods aim at
controlling the cost and quantity of credit,
I - Bank Rate or Discount Rate policy
Bank rate is discount rate of bills and government
securities held by the commercial banks. Credit
is controlled by lowering and increasing the
bank rate.
The market lending rates of commercial bank
changes with change in bank rate.

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 II – Open Market Operations
Selling and purchasing of securities and bonds of
Govt. and financial Institutions.
Central bank sells the securities to check
the expansion of credit and inflationary trend
and purchases to check recessionary trend.
III - Variable Reserve Ratio:
Banks are required to maintain Statutory
Liquidity Ratio (SLR) with them and maintain a
minimum amount or percentage of fixed
deposits (Reserve Ratio) with RBI.

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 2. Qualitative or Selective Credit Control
a) Regulation of Margin Requirement
b) Regulation of Consumer Credit
c) Rationing of Credit
d) Direct Action
e) Moral persuasion
f) Publicity

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Role of Central Bank in Economic
Development
1. Creation and Expansion of Financial Institutions
2. Proper Adjustment between Demand and
Supply of Money
3. A suitable Interest Rate Policy
4. Debt management
5. Credit Control
6. Solving the Balance of Payment problems

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COMMERCIAL BANKS
Excepting few, all banks in India commercial banks.
Excepting few : Reserve Bank of India,
Development banks ( Term lending financial
Institutions), Cooperative banks, etc.
So far definition of commercial banks is concerned,
with the increasing functions of commercial banks,
earlier definitions of have become irrelevant.

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Commercial Banks
According to Banking Companies Act 1949, “
A commercial Bank is an institution whose
business the accepting, for the purpose of lending
or investment, of deposits of money from the
public, repayable on demand or otherwise, and
withdrawable by cheque, draft or otherwise”.
Banking has been defined as functions of
banking.
“Banking is what bank does”.

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Functions of Commercial banks
1. Accepting deposits : Bank offer different types of schemes
to attract deposits.
2. Credit Creation : Commercial bank create credit by
lending more money than they have with them as cash
deposit.
3. Advancing loans and Making investments :
 Money at call : the loan can be called at very short notice.
 Over-draft : Permitting to overdraw from current account
up to an agreed limit.
 Bill discounting
 Cash Credits

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Functions of Commercial Bank
4. Agency Services : Commercial banks act as agent of
the customers. They provide following agency
services :
Remittance of funds
Collections and payment of dividends, bills,
cheques, etc.
Sale and purchase of securities
Representation and correspondence
Trusteeship : Bank act as attorneys, executors and
trustee of customers.
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Functions of Commercial Banks
5. General Utility services to customers:
 Letter of credit facilities
 Locker facilities
 Referee facilities
 Traveller’s cheques and bank drafts
 Underwriting of shares and bonds
 Collection of statistical information
6. Social functions:
 Serving of backward areas, weaker sections of society,
promotion of entrepreneurship, controlling of
speculation activities,
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Branch Banking and Unit Banking
Branch banking is a decetralised banking system
in which each commercial bank is very large
institution having a large number of branches all
over the country. This system is very popular in
the UK, India, Canada, Australia, South Africa,
etc,
UNIT Banking : Under this system each town has
its own bank which carries its operations from a
single office. This system originated in the USA.

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Sources of Commercial Bank Lending Power
Paid up Capital : Initial capital by issuing shares
Reserve Fund : It is that portion of the profits of a
bank which is not distributed among its share holders
as dividends.
Deposits : Deposits from customers
Borrowings : Borrowing from Central Bank

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Employment of Funds
Cash Reserves : necessary for liquidity
Dead stock : Fixed assets
Call loans : Short notice loans
Discounting of bills
Loans and Advances to cusotmers
Investments in securities

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Liabilities of a Bank
Share Capital of the Bank
Reserve Fund
Deposits : Time, Demand and Savings
Borrowing from other banks
Acceptance, endorsements on account of customers
Bank premises

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Assets of Commercial Bank
1. Cash in Hand and with Central banks
2. Money at call with short notice
3. Bills discounted including treasury bills
4. Investments in securities.
5. Advances against mortgaged assets
6. Liabilities of customers for acceptances,
endorsements, etc.

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Portfolio Management
Portfolio management is arranging assets and
liabilities in its quest for liquidity, solvency and
income.
LIQUIDITY : Liquidity is the capacity of bank to
produce cash in demand.
SOLVENCY : Solvency is the capacity of keeping
the realisable value of its assets equal to the value
of liabilities over the long run.
PROFITABILITY : Commercial banks are profit
maximising firms, hence after meeting the needs of
liquidity and solvency, they must try to maxiise
their income by minimising their variable costs.
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