Central Bank and Commercial Banks

Central bank and Commercial Banks
What is a central bank?
A central bank is a financial institution given privileged control over the production and
distribution of money and credit for a nation or a group of nations. In modern economies,
the central bank is usually responsible for the formulation of monetary policy and the
regulation of member banks.
Central banks are inherently non-market-based or even anti-competitive institutions.

Although some are nationalized, many central banks are not government agencies, and so
are often touted as being politically independent. However, even if a central bank is not
legally owned by the government, its privileges are established and protected by law.
Pakistan’s central bank is called State Bank of Pakistan.
History of the central banks:
The story of central banking goes back at least to the seventeenth century, to the founding
of the first institution recognized as a central bank, the Swedish Riksbank. Established in
1668 as a joint stock bank, it was chartered to lend the government funds and to act as a
clearing house for commerce. A few decades later (1694), the most famous central bank of
the era, the Bank of England, was founded also as a joint stock company to purchase
government debt. Other central banks were set up later in Europe for similar purposes,
though some were established to deal with monetary disarray. For example, the Banque de
France was established by Napoleon in 1800 to stabilize the currency after the
hyperinflation of paper money during the French Revolution, as well as to aid in
government finance. Early central banks issued private notes which served as currency, and
they often had a monopoly over such note issue.
While these early central banks helped fund the government’s debt, they were also private
entities that engaged in banking activities. Because they held the deposits of other banks,
they came to serve as banks for bankers, facilitating transactions between banks or
providing other banking services. They became the repository for most banks in the banking
system because of their large reserves and extensive networks of correspondent banks.
These factors allowed them to become the lender of last resort in the face of a financial
crisis. In other words, they became willing to provide emergency cash to their
correspondents in times of financial distress.
Functions of the central bank:
A central bank controls the supply of money as well as how it reaches the consumer. It can
not only print and inject money into the economy, but also regulate commercial banks
distribution of it.
The central bank controls monetary policy, which includes power over inflation, exchange
rates, and the money supply. It has several tools by which it uses to control such. For
example, it can set interest rates to control inflation, buy foreign currencies to weaken the
domestic currency, and engage in open market operations by purchasing assets from
financial institutions.
In turn, the central bank uses monetary tools to meet its objectives. These range from
country to country, but generally include targets for inflation, unemployment, economic
growth, and financial stability.
There are four main functions of a central bank
 Base Rate
 Open market operations
 Reserve requirements
 Foreign exchange reserves
Base rate:
Central bank sets a rate which commercial banks can borrow from the central bank. In turn,
commercial banks react with higher interest rates to the public as they are paying a higher
rate to the central bank.
Open market operations:

Open market operations simply involve central banks creating money and purchasing
financial assets with it. In recent times, it has come under the naming ‘Quantitative Easing’.
The aim of which is to take away either ‘toxic’ assets as we saw under quantitative easing,
or to buy up assets and free up money to invest elsewhere.
Reserve Requirements:
Central banks often use reserve requirements to increase and decrease the supply of
money. It does this by requiring each bank to keep back a certain percent of each deposit
they take in.
Foreign Exchange Reserve:

Central banks will usually hold a significant number of international currencies at any one
point, The aim of which is to be able to help stabilize fluctuations in the foreign exchange
market. For example, If the US dollar was to significantly lose its value, the Federal Reserve
may look to purchase US dollars with foreign currencies in order to increase its value.
Commercial Banks:
A commercial bank is a financial institution that is authorized by law to receive money from
businesses and individuals and lend money to them. Commercial banks are open to the
public and serve individuals, institutions, and businesses. A commercial bank is almost
certainly the type of bank you think of when you think about a bank because it is the type of
bank that most people regularly use.
Banks are regulated by federal and state laws depending on how they are organized and the
services they provide. Commercial banks are also monitored through the State Bank of
Pakistan.
Roles and Functions of the commercial banks:

The functions of commercial banks are classified into two main divisions.
Primary Functions:
 Accept Deposits
 Provides Loans and advances
 Credit cash
Secondary Functions:
 Discounting bills of exchange
 Overdraft facility
 Purchasing and selling securities
 Locker facility
Types of commercial banks:

There are 3 types of commercial banks.
1. Private Bank
2. Public Bank
3. Foreign Bank
Private bank:
It is a type of commercial banks where private individuals and businesses own most of the
share capital. All private banks are recorded as companies with limited liability. For
example, Askari Bank.
Public Bank:
It is a type of bank that is nationalised, and the government holds a significant stake. For
example, National Bank of Pakistan
Foreign Banks:
These banks are established in foreign countries and have branches in other countries. For
instance, the “Standard Chartered Bank” in Pakistan is a British owned bank.
The relation between Commercial Banks and Central Banks:
The relationship between the commercial banks and the central bank must be based on
reciprocity. The commercial banks should conform to the spirit of central bank directives
rather than letters. On the other side, the central bank should invariably satisfy the genuine
needs of the commercial banks in times of stresses and strains. A moral code of conduct
between the two will have to be evolved, accepted and followed. They contend that the
significant piece of the Central Bank's assets includes the stores of the commercial banks
implied for defending their wellbeing (liquidity). It would be unethical with respect to the
central bank to contend in business with the commercial banks with their money.
Considering the co-activity that the central bank frequently looks for from commercial
banks for doing its policies, the central bank shouldn't welcome antagonism from them by
giving them vile contest through its extraordinary honours as the bankers' bank and the
banker of the public authority.

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Central Bank and Commercial Banks

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Central bank and Commercial Banks

What is a central bank?

Central banks are inherently non-market-based or even anti-competitive institutions.

History of the central banks:

Functions of the central bank:

There are four main functions of a central bank

Open market operations:

Foreign Exchange Reserve:

Roles and Functions of the commercial banks:

Types of commercial banks:

The relation between Commercial Banks and Central Banks:

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