Rationale In Establishing The Central Bank – The central bank in most countries has several important functions they perform, however, the call for the establishment of the central bank often does not relegate the rationale in establishing the central bank.
One of the aims behind the rationale in establishing the central bank complex arises mostly from non banking reasons. From the experience of various countries, the rationale for the emergence of the establishment of the central bank often arises from the following
- The need to rescue other banks from failing
- The need to help government achieve political goals
- To enhance nationalism
- To help reduce all forms of international pressures
Fractional Reserve Banking System | Rationale In Establishing The Central Bank
Commercial banks operate fractional reserve system. Fractional reserve banking refers to a system where banks keep only a fraction of their money and lend out the rest. Once in a while there comes a time of business recession or a situation may arise that will shake people’s confidence in the banking services. Such situation has risen in many developing countries like in India or even in Nigeria when there was political crisis.
In time of political crisis, people will be afraid that the bank might fail. These type of fear can either be real or imaginary. But the end product of this is that it creates panic and everyone will usually rush to the bank to withdraw their money. This situation is called bank run or bank panic. That is, when all customers come for their money at the same time, the factional reserve cannot be enough for all. The bank will be forced to fail. When banks fail in this manner, concerned citizens will call on the government to intervene in order to ensure the safety of banks. The demand at this point in time is the call for a central bank complex to be established.
The bank failures of 1907 in the United State Of America led to the call for government to establish a central bank. This led to the establishment of the federal reserve system in the year 1913. The rationale in establishing the central bank serves as a lender of last resort which helps to ensure the safety of banks
Political Reasons | Importance Of Central Bank Independence
Government of various countries would want to discharge their functions effectively to avoid much criticism. However, the government often does not have enough money to pursue its lofty programs, in such situations, the government needs a bank to borrow from, one of such central bank that where set up for political reason is the bank of England. The bank was set up to help finance the war between England and Arabians. The bank also helped to finance the second world war.
With the above, you now can see the reasons for central bank independence. However, the central bank also helps the government to control the supply of money and credit. By centralizing the issue of currency notes, the government could afford to issue notes that have partial backing or even no backing at all to finance its budget deficit. The rationale in establishing the central bank lies in the need to control the entire economy by the government and also made communism countries government to create central banks.
Nationalistic tendencies were one of the major reasons that led to the establishment of central banks in most developing countries of the world. In the process of the process to become an independent nation, the nationalist often demand that a central bank be established for their country. Without theh central bank, colonised countries had no option that to fall back under the control of the central banks of their colonial masters.
Just like the former British colonies like Ghana and Liberia got their central banks respectively, though nationalistic moves. Their arguments were logical. They needed a central bank to be like other nations and to enjoy international financial relations with other countries of the world.
Some countries rationale in establishing the central bank comes as a result of pressure from the international communities. At the international financial conference held in Brussels in 1920 a resolution was passed that countries that had no central bank should establish one as soon as possible. After the formation of the IMF following another conference held in 1944, many countries were advised to establish a central bank to enhance better central dealing with the IMF. This formed the rationale for establishing central banks in some countries.
Harmonization And Standardization Of Currency Note Issue
Central banking at this early stage also became necessary because of the need to maintain a standard in the minting of currency notes and coins. When goldsmiths and individual banks were issuing their own currencies it was common for dubious Goldsmith (bankers) to issue currencies that were substandard. For instance 9.5 pounds weigh of gold can be issue as 10 pound weight of gold. The difference may not be noticed unless they are weighed. Some dubious banks could also issue fake gold receipts that had no backing. To avoid such sharp practices, it became necessary that the job of issuing currency notes and coin be centralized in a government owned bank.
Moreover, each country of the world had a need to issue its own currency, if not for any other thing, it gives them a national identify. This propelled many countries to establish a central bank to serve as a bank of issue. The rationale in establishing the central bank vary widely with those for establishing commercial and other banks. In the case of commercial bank and merchant banks, the main rationale for their establishment is to make profit.
Functions Of A Central Bank
Apart from the variations, the functions performed by central banks of various countries are virtually the same. The variations often arises from difference in the level of each country’s economic developments.
While the central banks of developed countries may concentrate on the traditional functions of a central bank, those of the developing countries perform more of development functions. Such developmental functions may even require the offer of direct banking services to the public.
The rationale in establishing the central bank responds to the functions performed by a central bank according to their various categories will normally include the following,
- Banking Functions – The banking functions of the central bank according to banking functions are as follows; Issuance and distribution of currency, banker and financial adviser to the government, banker to other banks and financial institution, lender of last resort, clearing and collection of cheques and other instruments.
- Monetary Control Functions – The monetary control function of the central bank includes the following, control of credit and money supply (liquidity management), Regulation and supervision of the financial system.
- Foreign operation Functions – The foreign operational functions of the central bank includes the maintenance of external reserves, exchange equalization account and foreign exchange control, representation in international financial institutions.
- Debt Management Functions – Debt maintenance function of the central bank includes Management of internal and external debt.
- Development Functions – Here are the developmental functions central bank handle, they includes developments of money and capital markets, development of research and stastical data collection and collation.
Establishment And Date Of Central Bank In Different Countries
- Britain – Bank Of England Established in 1694
- France – Bank Of France Established in 1800
- Germany – German Reichsbank 1878
- Netherlands – Netherlands Bank 1814
- Australia – Australian National Bank 1878
- Norway – Bank Of Norway – 1817
- Denmark – National Bank Of Denmark – 1818
- Belgium – National Bank Of Belgium – 1850
- Spain – National Bank Of Spain – 1856
- Russia – State Bank Of Russia – 1860
- Japan – Bank Of Japan – 1882
- Italy – Bank Of Italy (Banca d’ Italia) 1893
- Switzerland – Swiss National Bank – 1907
- America (USA) – Federal Reserve System – 1913
- Canada – Bank Of Canada – 1934
- Nigeria – Central Bank Of Nigeria – 1958
- India – Reserve Bank Of India – 1935
- Hungary – National Bank Of Hungary – 1967
In conclusion, the rationale in establishing the central bank revolves around the regulation of the financial system, as well as managing financial institutions and government agencies