CENTRAL BANK

1
CENTRAL BANK

• General functions
• Issuance of currency
• - The Central Bank normally has complete control
  over this function. However in some countries
  commercial banks also issue notes e.g. Northern
  Ireland and Scotland. This can lead to a problem
  where such notes are not recognised elsewhere in
  the UK
• Management of Exchange Rates
• - The Central Bank has power to (artificially)
  influence the exchange rate of a currency. For
  example if a currency e.g. sterling is deemed too
  weak, the Central Bank (Bank of England) could
  use other reserve currencies such as euros and
  dollars to buy sterling on the foreign exchange
  markets. This would  increase the demand for
  sterling and thereby its price
• Management of Gold Reserves
• - Though it is a relic of the past when
  commodity money was used Central Banks still have
  gold in their reserves which they are entrusted
  to guard safely

2
CENTRAL BANK (con)

• Government Bank
• Holder of Government account
• - just as a commercial bank acts for the public,
  the Central Bank acts for the Government holding
  (and managing) its very large account
• Management of Debt
• - The Government will generally require to
  borrow money which can be raised through the
  issuing of various types of government securities
  (gilts). The Central Bank generally manage this
  function though for some years now in Ireland it
  has been carried out by a specialist body - the
  NTMA (National Treasury Management Agency).
• Advises on economic policy
• - A considerable amount of research into
  economic developments in the economy is carried
  out by the Central Bank. It then advises the
  Government (usually advocating prudence and
  caution) in its conduct of economic policy. This
  advice (in Ireland) is contained in the Central
  Bank Bulletin (published each quarter).

3
CENTRAL BANK (con)

• Bankers Bank
• Licensing and supervising authority
• - In order to operate a bank must obtain a
  license that is issued by the Central Bank which
  can be taken away in the case of misconduct. Also
  the Central Bank is generally entrusted with the
  day to day supervision of the financial system.
  In Ireland another special body - which is
  however closely associated with the Central Bank
  - has been set up for this purpose. It is called
  the Financial Services Regulatory Authority
• Holds Deposits of Financial Institutions
• - Banks hold their own accounts with the Central
  Bank. At the end of each day they settle up their
  own debts with each other through cheques drawn
  on these accounts (clearing accounts). Also for
  security reasons they need to minimise the amount
  of cash kept on the premises. So most of this
  cash is held for safe keeping with the Central
  Bank
• Sets reserve requirements
• - Though vital for meeting customer
  requirements, the holding of cash is not
  profitable for banks. Thus there is a need for
  reserve ratios whereby they are legally required
  to hold a certain percentage of their reserves in
  cash. This ratio is set by the Central Bank.

4
CENTRAL BANK (con)

• Provides Lending Facility
• - The Central Bank also provides a lending
  facility for the banks which enables them to
  obtain additional liquidity if in danger of
  running short of cash. The "Bank Rate" is the
  rate of interest charged by the Central Bank for
  this purpose and can represent an important use
  of monetary policy. Though the Central Bank can
  act as "lender of last resort" in a dire
  emergency, normally this is not exercised
• Applies Additional Measures when Required
• - The Central Bank can call for additional
  deposits to be made with it (for example when too
  much credit is extended). Also in certain cases
  it may impose penalty restrictions on banks for
  extending too much credit.

5
MONETARY POLICY

• Central Bank Responsible for Monetary Policy Key
  elements
• Control of money supply. It is important to
  control the amount of money in circulation.
  Though putting extra money into circulation can
  stimulate economic activity, too much money can
  lead to inflation
• 2. Changing the interest rate.  Interest rates
  throughout the financial sector are closely
  related to each other. Therefore if The Central
  Bank lowers its own rate  this usually leads to a
  general reduction in interest rates which
  stimulates economic activity (through additional
  investment and consumer spending)
• 3. Managing the exchange rate. The value of the
  exchange rate with other currencies is very
  important as it affects trade. For example due to
  the recent rise of the euro against the dollar,
  it is now cheaper to import goods from the US
  (and to visit there on holiday). However it is
  more expensive to sell goods into the US market.
  Though the Central Bank can affect the exchange
  rate, it generally does not intervene in this
  manner
• 4. Other measures. Formerly credit controls were
  widely used in Ireland, though with the single
  financial market in Europe these are no longer
  used. However other measures such as reserve
  ratios and banking legislation can also impact on
  monetary policy.    

6
EUROPEAN CENTRAL BANK

• Since 1998 all national Central Banks are part
  of the European system. This federal arrangement
  is referred to as the European System of Central
  Banks (ECSB) with decisions taken by an executive
  board - referred to as the European Central Bank
  (ECB)
• Most of the traditional functions of national
  Central Banks are now controlled by the ECB.  
• Currency i.e. the Euro is now issued through the
  ECB our national Central Bank then acts as an
  agent for the ECB in printing notes and minting
  coins for the Irish economy
• The power to control exchange rates for Eurozone
  countries has now ceased
• The terms (interest rate) on which lending to
  other banks is now set is through the European
  Central Bank. Therefore the ECB can control the
  overall amount of credit extended
• The European Central Bank also controls the
  reserve ratio of the banks

7
EUROPEAN CENTRAL BANK (con)

• However the national Central Bank still can play
  a regulatory role though this now
• exercised through The Financial Services
  Authority of Ireland  
• The National Central Bank still acts a banker to
  the Government.
• However the amount which can be lent out (and the
  manner in which borrowing takes place) is again
  controlled at a European level
• So overall now the role of the national Central
  Banks (within the EMU) is to carry out the policy
  that has been agreed at a European level
• In other words independent monetary policy - with
  respect to money supply, interest rates or
  exchange rates - has now ceased for Eurozone
  countries