Central bank and economic development

In this editorial, articles published in The Hindu, The Indian Express, Business Line etc. are analyzed. This article discusses the central bank and its role in economic development. It is also mentioned in the context of India. In-place team vision inputs are also included, as needed.

The reference
Central bank and economic development : In almost all countries of the world, the central bank is seen as a supreme monetary authority and accordingly has to perform various useful functions to ensure the smooth operation of the economy. The central bank of a country has to bear the responsibilities of stability and economic development in the country’s economy along with its traditional functions.

Central bank concept

  • The central bank is generally defined as a financial institution, which is given the privilege to create funds and provide loans to a nation or group of nations.
  • The central bank plays an important role in the development of a country’s economy and prevents the banking system from failing.
  • In modern economies, the central bank is usually responsible for the formation of monetary policy and regulation of member banks.
  • It is noteworthy that central banks are generally free from competition.
  • An important feature of the central bank is its legal monopoly status, under which it enjoys the right to issue banknotes and cash and this position makes it different from other banks.

Global history of central banking system

  • It is important to note that the oldest central bank in the world is the Bank of Sweden, which was opened in the year 1668 with the help of Dutch traders.
  • Subsequently, in the year 1694, the Bank of England was created by Scottish businessman William Patterson at the request of the British Government to finance the war.
  • Other early central banks, notably Napoleon’s Bank of France and the Reichbank of Germany, were also established to finance costly government military operations.
  • It is noteworthy that the Federal Reserve System of America’s central bank was created in the year 1913 by the US Congress by passing a bill.
  • Additionally, the People’s Bank of China was established as a central bank in China in the year 1979 with the introduction of Chinese market reforms.
  • Today there is hardly any country that does not have a central bank. Initially central banks were privately owned and managed and controlled by private entities only. But now most of the central banks have been nationalized or recognized as state-owned institutions, especially after the Second World War.
Central bank
Central bank

Difference between central bank and commercial bank

  • The primary objective of any central bank is not to make profit, while the primary purpose of almost all commercial banks is to earn profit.
  • The central bank does not carry out common banking functions such as accepting deposits of common people and creating credit by lending to them, etc. On the contrary, these two functions are the main functions of commercial banks.
  • A central bank is legally empowered to regulate and regulate the banking activities of commercial banks. Commercial banks do not receive any such power.
  • While the central bank acts as the bank of the government, commercial banks function as the public bank.
  • Credit is created by commercial banks, while credit is controlled by the central bank.

Role of central bank in economic development

Money supply for financing development schemes

For developing countries like India, it is necessary to launch big development projects to speed up their development. The government requires a lot of money for this task and the central bank, being the only authority to issue money, can help the government by supplying money.

Resource mobilization and adequate credit supply
Mobilizing resources for the purpose of development is essential in a developing economy. In such a situation the central bank can assist the government in mobilizing domestic resources to finance development plans through several measures (eg strengthening the banking structure).

Increase flow of bank credit to priority sectors
Setting priorities for development is an essential feature of a development plan. The country’s central bank constructs its monetary and credit policy in such a way that large and desirable amounts of bank credit are invested in areas that need it, such as agriculture, cooperatives, small industries and export trade. It also serves to maintain price stability and ensure proper utilization of bank credit.

Controlling inflation
The central bank also performs important tasks like controlling inflation in the economy, through which it is ensured that the estimated cost of various schemes set by the government does not exceed their actual cost. Also, another objective of controlling inflation is to reduce the economic burden of the poor people of the country.

Foreign exchange reserves management
In India, RBI is the custodian of foreign exchange reserves and it also has the right to take decisions related to investment of currency reserves. The RBI holds the currency of various countries and through that it controls the price of the rupee.

India and central bank

  • The Reserve Bank of India (RBI) is the central bank of India which was established on April 1, 1935 under the provisions of the Reserve Bank of India Act, 1934.
  • Like other economies, the RBI in India also plays an important role in the management and monitoring of the country’s banking system and monetary policies affecting the economy.
  • The RBI also controls some decisions regarding the country’s currency.
  • The main functions of RBI in relation to India:
    • Formulation, implementation and monitoring of monetary policy.
    • Issue of currency.
    • Acting as a banker and loan manager of the Government of India.
    • Acting as a banker to commercial banks.
    • Acting as a regulator and supervisor of the financial system.
    • Managing foreign exchange for India.
    • Acting as a regulator and supervisor of payment and settlement systems.
    • Maintaining financial stability in the country.
    • To ensure the overall development of India.

The conclusion

The central bank of any country acts as the backbone of that country’s economic system and its role in the economic development of the country cannot be denied. In the last few years, India has emerged as the fastest developing nation in the world and due to its influence many unique challenges have arisen before India, it is necessary to deal with these challenges that the government of the country and the central Banks ie RBI should work in an integrated manner so as to ensure the long term development of the country.

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