Lesson 26
Central Banking
Origins of the central
banking
Lecture No. 112
Central Bank
A Central bank is a government authority in charge of
monetary policy
Central bank’s actions affect interest rate, amount of
credit and money supply
Central bank’s actions affect financial market, economic
activity, exchange rate and inflation
The oldest central banks
Sveriges Riksbank or the Bank of Sweden was the first
central bank
Established in 1668
Bank of England was established in 1694
Functions of old central banks
Function of Sveriges Riksbank: lending money to the
government of Sweden.
Buying government debt
Securing cashless international payments to increase
efficiency
To maintain monetary stability
Federal Reserve System
Opposition of establishing a central bank because of concentration of
powers
But financial crises during 1870 to 1907 led to weaken this opposition
Federal reserve system was established in 1913
To avoid power concentration, power was distributed among 12
regional Federal Reserve Banks
Privately owned by its member banks
Establishment of Central banks in emerging
economies
Many emerging market economies established their
central banks after world war II.
They established central banks a few years after their
independence from colonialism.
The structure of these banks was very similar to those of
European central banks.
Ownership of central banks
Different ownership structures; e.g.
Bank of Italy is privately owned by commercial bank members
Fed is partially privately owned and partially publicly owned
European central bank is owned by central banks of member states
Small fraction of shares of some central banks is privately owned; e.g.
Belgium, Greece, Switzerland, Japan, Turkey, South Africa
Changing Functions of Central Banks
Historically different functions were set like;
Issuing bank notes
Regulating banks
Monitoring international payment system
Regulating exchange rate
Financing government
Supporting banks with short liquidity.
Functions of a Central Bank
-I
Lecture No. 113
Currency regulator/issuer
Central banks possess exclusive rights to issue currency,
especially notes
A central bank is also called ‘Bank of Issue’
If all banks are allowed this function then economy will be
disorganized
Money supply can be regulated only if there is one issuing
authority
Bank to the Government
Accepts deposits from and makes payments to or on
behalf of government
May also lend to or on behalf of the government
Act as an advisor to the government in the areas of
economic policy, capital market and money market
Custodian of Cash Reserves
Central bank is bankers’ bank
Holds commercial banks’ deposits known as reserves
All transactions between central bank and commercial banks and
between commercial banks are done through these reserve accounts
Commercial banks may maintain reserves as insurance against
unexpected large withdrawals
Custodian of International Currency
Central banks maintain foreign exchange reserves
To manage emergency needs of foreign reserves
To manage deficit on external account / avoiding excess
fluctuations in exchange rate
Lender of last resort
Discount loans to commercial banks
In case of a bank is liquidity constrained
Short term loan
Using government securities as collateral
Protecting financial system from collapsing
Functions of a Central Bank
- II
Lecture No. 114
Clearing House for banks’ transactions
Interbank check clearance
Through reserve accounts of commercial banks with the
central bank
To facilitate banks’ checks for use of medium of exchange
For efficiency of payments and economic transactions
Controlling cost of credit
Credit creation by commercial banks may not align with
the objectives of economic policy
Central banks can change interest rates charged on loans
to commercial banks and paid to them on excess reserves
To mainly change demand for credit
Controlling credit creation
Commercial banks create credit
Excess credit creation may cause inflation, while less creation causes
recession
Central bank controls/regulate credit creation by:
Changing excess reserves through open market operations
Changing required reserve ratio on deposits
To mainly change supply of credit
Protecting depositors/savers’ interest
Commercial banks may exploit depositors
Financial system collapse results in depositors losing
money
Keeping real interest rate for depositors at reasonable
level.
Functions of the State bank
of Pakistan
Lecture No. 115
Functions of SBP as mentioned in SBP Act,
1956 Amended in 2022
To determine and implement monetary policy;
To formulate and implement the exchange rate policy;
To carry out and disseminate research relevant to Bank's
objectives and functions;
Functions of SBP as mentioned in SBP Act,
1956 Amended in 2022
To hold and manage all international reserves of Pakistan;
To issue and manage the currency of Pakistan, including
regulating their denominations;
To collect and produce statistics relevant to the Bank's
objectives and functions;
Functions of SBP as mentioned in SBP Act,
1956 Amended in 2022
To operate and exercise oversight over payment systems;
To act as lender of last resort;
To license, regulate and supervise scheduled banks and financial
institutions that fall under the domain of the Bank as further specified
in this Act or any other Act;
To resolve scheduled banks and other financial institutions that fall
under the domain of the Bank as further specified in this Act or any
other Act;
Functions of SBP as mentioned in SBP Act,
1956 Amended in 2022
To adopt and implement macro-prudential policy measures for
scheduled banks and financial institutions that fall under the domain
of the Bank;
To act as the banker, financial adviser and fiscal agent to the
Government, and its agencies, on the mutually agreed terms and
conditions;
To promote financial inclusion in Pakistan;
Functions of SBP as mentioned in SBP Act,
1956 Amended in 2022
To develop financial market infrastructures;
To participate in international councils and organizations,
including multilateral, international financial institutions,
To cooperate with domestic and foreign public entities,
concerning matters related to its objectives and functions;
To carry out any ancillary activities incidental to the exercise
of its objectives under this Act.".
