Roles and Objectives of Central Banks | CFA Level 1 - AnalystPrep (2024)

Objectives of Central Banks

The main objective of a central bank is to ensure financial stability. Depending on the country, central banks might have other objectives such as controlling inflation, unemployment, interest rates, or exchange rates. However, all these objectives are in line with the main objective of ensuring financial stability.

Roles of Central Banks

To ensure financial stability, central banks execute the roles discussed below.

1. Currency Regulation

Central banks have the monopoly of issuing notes, and these notes issued by central banks act as legal tender of money. Each central bank has an issue department that issues coins and notes to commercial banks. Even though the government manufactures these notes and coins, they are circulated by the central bank. Therefore, the money put in circulation must be monitored to ensure that there is just the right amount in circulation.

2. Control of Commercial Banks

All commercial banks are obligated to prepare and submit a report of their undertaking to the central bank after a given period of time. These statistics are important in decision-making in the finance sector. The central bank can influence the activities of commercial banks through its monetary policies.

3. Banker, Fiscal Agent, and Adviser to the Government

The central bank receives deposits on behalf of the government from sources such as income tax and foreign aid. It also makes payments on behalf of the government. Moreover, the central bank advises the government on economic and monetary matters such as inflation and deficit financing. The government also gets short-term loans from the central bank.

4. Controller of Credit

The control of credit is realized through the use of the monetary policy. The central bank controls the credit creation power of commercial banks to curb inflationary and deflationary pressures on the economy.

5. Custodian of Cash Reserves of Commercial Banks

The law requires that commercial banks keep a particular percentage of reserves in the central bank. It is on this basis that the central bank transfers money from one bank to another to facilitate the clearance of cheques. A central bank is, therefore, a bank to commercial banks.

6. Lender of Last Resort

Commercial banks normally borrow from discount houses. However, during times of financial problems, they can seek funds from the central bank by borrowing at the market rate instead of the bank rates given by discount houses.

Question

Credit control refers to actions undertaken by central banks to:

A. control imports and exports;

B. control the money creation of the government; or

C. control inflation.

Solution

The correct answer is C.

The central bank controls the credit creation process by commercial banks so as to control inflationary and deflationary pressures on the economy.

Reading 16 LOS 16f:

describe roles and objectives of central banks

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