SELECTIVE BANK AND ITS FUNCTION

INTRODUCTION

In the monetary system of all countries, the central bank occupies an important place.
The central bank is an apex institution of the monetary system which seeks to regulate the
functioning of the commercial banks of a country. The central bank of India is called the
Reverse Bank of India which was set up in 1935. The commercial banks keep only a fraction
of their deposits in cash and the rest they lend out to the traders and investors. Therefore, the
commercial banking is often known as fractional reserve system. In view of the fact that
commercial banks keep only a fraction of their deposits in cash, they will run into difficulties
if at a time there is rush of depositors to withdraw their money.

This indicates the need for an institution which should come to the rescue of the
commercial banks and provide them the money required to meet the excessive demand of the
depositors. The central bank fulfills this need. However, in the modern times, the central bank
not only provides monetary aid to the commercial banks in time of crisis but performs many
other functions. Indeed, the control over cost and availability of credit in the economy and
regulation of the growth of money supply are special responsibilities of the central bank.

The Principles of Central Banking:

The central bank of a country enjoys a special status in the banking structure of-the
country. The principles on which a central bank is run differ from the ordinary banking
principles. An ordinary bank is run for profits.

A central bank, on the other hand, is primarily meant to promote the financial and
economic stability of the country. The guiding principle of a central bank, says De Kock,
is that it should act only in the public interest and for and welfare of the country and without
regard to profit as primary consideration. Earning of profit for a central bank is thus a
secondary consideration.

The central bank is thus not a profit hunting institution. It does not act as rival of other
banks. In fact, it is a monetary authority of the country and has to function in a manner so as
to promote economic stability and development.

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 The functions of the central bank especially the Reserve Bank of India have increased
enormously in recent years. Not only does the Reserve Bank of India regulate credit and
money supply in the country but it promotes economic development and price stability.
Guiding principles of the Reserve Bank are to operate its most instruments in a way that
serves the objectives of economic policy laid down by the Government and Planning
Commission.

Functions of Central Bank:

The following are the main functions of a central bank:

1. It acts as a note issuing agency.

2. It acts as the banker to the state.

3. It acts as the bankers bank.

4. It controls credit.

5. It acts as the lender of the last resort.

6. It manages exchange rate.

Note Issuing Agency:

The central bank of the country has the monopoly of issuing notes or paper currency
to the public. Therefore, the central bank of the country exercises control over the supply of
currency in the country. In India with the exception of one rupee notes which are issued by
the Ministry of Finance of the Government of India, the entire note issue is done by the
Reserve Bank of India. In the past the central bank of various countries used to keep as
reserves some gold and foreign exchange securities against the notes issued.

The percentage of the reserves to be kept against the total amount of notes issued was
fixed by law and is subject to change by the Government. Theoretically, there is no need of
the backing of gold reserves against the notes issued. It may be pointed out that paper notes
these days cannot be converted into gold or some other precious metals; they are
inconvertible.

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 This is called proportional reserve system. Before 1956 in India also, there was
proportional reserve system of issuing currency or notes. According to this, the Reserve Bank
was required to keep as reserves 40 per cent of the total notes issued in the form of gold and
foreign exchange securities.

Since 1956 this system has been given up and instead minimum reserve system has
been adopted according to which the Reserve Bank is required to keep only a minimum
amount of reserves in the form of gold and foreign exchange securities and given this
minimum reserve it can issue notes as much as it thinks desirable in view of the needs and
conditions of the economy.

There is even no need for backing of gold for the currency issued by the Government
or the central bank. From the economic point of view what matters is the production of real
goods and services and not the amount of gold supporting a currency. The real value of a
currency depends on how much it can buy goods and services and not how much gold or
silver is kept as reserve against it. Thus, ultimately the credibility of the currency of a country
depends not upon whether it is convertible into gold or silver but upon to what extent it is
possible to maintain the stability of its value by suitable monetary control.

Banker to the Government:

Another important function of the central bank is to act as the banker to the
Government. All the balances of the Government are kept with the central bank. On these
balances the central bank pays no interest. The central bank receives and makes all payments
on behalf of the Government. Further, the central bank has to manage the public debt and also
to arrange for the issue of new loans on behalf of the Government.

The central bank also provides short-term loans to the Government. This is usually
done through the central bank discounting the Government treasury bills either directly or
when presented by other banks. Thus the central bank performs a number of services to the
Government. In fact, the central bank is the fiscal agent of the Government and advises the
latter in matters relating to currency and exchange as well as finance.

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Bakers Bank:

Broadly speaking, the central bank acts as a bankers bank in three capacities:

(i) As the custodian of the cash reserves of the commercial banks;

(ii) as the lender of the last resort; and

(iii) as bank of central clearance, settlement and transfers.

All other banks in the country are found by law to keep a fixed portion of their total
deposits as reserves with the central bank. These reserves help the central bank to control the
issue of credit by commercial banks.

They in return can depend upon the central bank for support at the time of emergency.
This help may of in the form of a loan on the strength of approved securities or through
rediscounting of bills of exchange. Thus the central bank is the lender of the last resort for
other banks in difficult times because on such occasions there is no hope of getting help from
any competing institution.

In India, scheduled banks have to keep deposits with the Reserve Bank not less than
5% of their current demand deposits and 2% of their fixed deposits as reserves. In return they
enjoy the privilege of rediscounting their bills with the Reserve Bank as well as securing
loans against approved securities when in need.

Control of Credit:

The chief objective of the central bank is to maintain price and economic stability.
Price instabilityboth inflation and deflationhas harmful effects. Moreover, fluctuations in
overall economic activity, that is, trade cycles entail a lot of human sufferings.

Main reason for the fluctuations in prices as well as in overall economic activity is the
changes in aggregate demand. Aggregate demand, especially the investment demand,
depends upon the supply of money. And credit these days is the important constituent of the
money supply. Thus the supply of credit greatly affects the prices, national income and
employment through changes in investment demand.

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CONCLUSION

Now it is the responsibility of the central bank of a country to guide the money
market, i.e., the commercial banks regarding supply of credit so as to maintain stability in
prices as well as in overall economic activity. To overcome inflation it has to restrict the
supply of credit and to prevent or get rid of depression and deflation it has to expand the
credit. There are various methods by which the central bank can control the supply of credit
in the economy.

REFERENCE

http://www.yourarticlelibrary.com/banking/central-banking-meaning-function-
methods-and-selective-credit-control/37875/
http://www.yourarticlelibrary.com/banking/4-methods-used-by-the-central-bank-for-
credit-control-banking/11035/
http://www.yourarticlelibrary.com/banking/selective-credit-control-scc-methods-
used-by-the-central-banks/24800/
https://en.wikipedia.org/wiki/Credit_control_in_India