Central Bank and Depository Institutions - Essay Example

CENTRAL BANK AND DEPOSITORY S By + Table of Contents CENTRAL BANK AND DEPOSITORY INSTITUTIONS 3 An Overview of the Central Bank 3 An Overview of Depository Institutions 3 Functions of the Central Bank 4 Central Bank as Banker to the Government 4 Central Bank as Bank of Note Issue 4 The Functions and Services Provided by a Depository Institution 5 Accepting Deposits 5 Disbursement of Payment 5 Credit Creation 6 Provision of Loans to its Customers 6 Accepting Bills of Payment 6 Dealing in Foreign Exchange Transactions 6 Accepting Tax Proceeds and Tax Returns 6 Provision of Cards 7 Purchasing and Selling Securities 7 Summary Conclusions and Recommendations 7 References and Bibliography 8 CENTRAL BANK AND DEPOSITORY INSTITUTIONS An Overview of the Central Bank Central is an independent institution which standardizes state currency, interest rates and manages money resource in the economy. It is directed by a chief executive who is habitually known as the governor, president or chairman. The regulation of currency by the central bank aids to bring back inflationary and deflationary situations to the stability of the economy. The central bank also supervises the banking system of commercial banks that do function in its economy so as to monitor the money supply in the economy. Unlike commercial banks, the central bank delights in the monopoly of accumulating the financial base of a state and also it do prints the national currency which functions and acts as the state’s legal tender. This particular institution is considered to be independent from political intervention though restricted regulation by the executive and legislative bodies does exist. The central bank enjoys supervisory controls over other financial institutions. This helps in decreasing the risk that commercial banks and other financial institutions might indulge in fraudulent practices that may negatively affect a nation’s economy. An Overview of Depository Institutions A depository institution is a financial institution like commercial bank, savings bank and credit union that is lawfully permitted to receive deposits from its customers and provide them commercial credits. The federal depository institutions are controlled by the Federal Deposit Insurance Corporation in the United States. Depository institutions are also regulated by the central bank in a number of ways so as to manage the money supply in the economy. They are also obligated by the central bank to conserve the reserve prerequisite as specified. Functions of the Central Bank The central bank generally executes the following functions: banker, agent and advisor to the government; bank of note issue; bankers’ bank; lender of last resort and controller of credit. Central Bank as Banker to the Government The central bank functions as a banker, agent and financial advisor to the government. As a banker to the government, it plays the same role as a commercial bank does to its customers. It keeps the accounts of both the central government and the state government. It accepts payments from the government and offers short term credits to the government. It accumulates cheques and drafts put in the government account. It conveys overseas exchange capitals to the government for paying back marginal arrears or in the procurement of foreign goods. As an agent to the government, it collects taxes and other payments on behalf of the government. It also raises loans from the public thus managing public liability. The central bank also represents the government in external financial institutions in conferences. It equally acts as a financial advisor to the government through giving it advice on economic, monetary, financial and fiscal issues (Goldthwaite, 1995). Central Bank as Bank of Note Issue The central bank enjoys the sole dominance of issuance of notes. The currency printed and issued by the central bank has got an unconstrained legal tender throughout the country (Macesich & George, 2000). This helps to bring homogeneity in the monetary system of note issue and circulation. The central bank is in a position to exercise better control over the money supply in the country. This escalates the public confidence towards the monetary system of the country. This function also allows the central bank to exercise control over credit creation by commercial banks. Profit is also earned by the central bank from the issuance of paper currency. The monopoly right that has been granted to the central bank helps to avoid political intrusion in the matter of note issue. The Functions and Services Provided by a Depository Institution Commercial banks, as an example of depository institutions, have been identified for this particular discussion. Commercial banks perform various functions and offer a number of services in the financial market. These functions and services include accepting deposits, disbursement of payments, credit creation, providing loans to its customers, dealing in foreign exchange transactions, accepts various bills of payment, accepts tax proceeds and tax returns, providing various cards and purchasing and selling securities. Accepting Deposits Commercial banks accept deposits that are usually in form of money from individuals and businesses who are customers to those particular banks. The depositors have to open an account with the commercial banks for them to be able to deposit money and other securities with them. This acts as a deflationary measure through the taking of excess money that is circulating in the economy. Disbursement of Payment Commercial banks can make payments on behalf of its customers upon the direction of its depositors. This would include the honoring of cheques that have been written by its depositors. Credit Creation This is the most significant function of commercial banks. During the process of sanction of a loan to a customer, commercial banks do not provide cash to the borrower. They instead open a deposit account from which the loan borrower can withdraw its cash. This process is referred to as credit creation in the financial markets. Provision of Loans to its Customers Commercial banks provide loans and various forms of advances to its customers. This includes an overdraft facility, cash credit, bill discounting and many other forms of advances. They also do provide demand and term loans to different types of customers against proper security. Accepting Bills of Payment Commercial banks accept phone bills, gas bills, water bills, electricity bills and many other types of bills. This gives its customers a convenient and secure way to pay their bills. Dealing in Foreign Exchange Transactions Commercial banks perform the function of exchange of currencies. This enables its customers to exchange their money to their preferred currency at any time and place. Accepting Tax Proceeds and Tax Returns Commercial banks act as agents to the national government in the collection of tax proceeds and tax returns especially from employees and businessmen in the nation (Mishler & Cole, 1995). This gives the government a convenient way to collect taxes and helps to eradicated tax avoidance and evasion. Provision of Cards Commercial banks provide credit cards, smart cards, debit cards and other forms of cards to its customers. This helps the public to use the cashless form of transaction in the economy hence enabling the regulation of money supply in the economy. Cards also offer a form of security to the customers’ money as they do not have to perform their business transactions using liquid cash (Mankiw, 2002). Purchasing and Selling Securities Commercial banks act as an agent through the buying and selling of securities in the financial markets especially in the securities exchange (Acocella, Di & Hughes, 2012). Summary Conclusions and Recommendations It is argued that the central bank is self-governing only in theory but in practice it is not. This is due to external sways like political elements. The governors of the central bank are employed by the government and sometimes they would be influenced to perform what the government wants. This makes the central bank to lose its objectivity. The governors would also be doing this so as to keep their jobs since the government has the supremacy to hire and to fire them. This basically affects its responsibilities in the conveyance of services to the public. Therefore, for the central bank to efficiently perform its legitimate duties, its independency has to be upheld by all the relevant authorities. Commercial banks too need to be controlled so as to regulate the flow of money in the economy. This will help deal with various monetary disasters that can arise particularly during inflation or depletion. This will ensure that the economy keeps its stability. References and Bibliography Acocella, N., Di, B. G. & Hughes, H. A., (2012). Central banks and economic policy after the crisis. Oxford University Press: Survey of Internal Finance. Federal Reserve Board, (2003). Federal Reserve Act. US. Hoggson, N.F. (1926). Banking through the ages. New York: Dodd, Mead and company. Macesich & George, (2010). Central banking: The earlier years: Issues in Money and Banking. Matyszak & Phillip, (2007). Ancient Rome on five penarii a day. New York: Thames and Hudson, p.144 Mishler, L., Cole, R. E., (1995). Consumer and business credit management. Homewood: Irwin, p.120-129 Mankiw, N. & Gregory, (2002). Money supply and money demand. Read More