Business finance (pt 2)
Yvonne Harvey, Contributor

Good day to you all. You will remember that, last week, we began the business finance section of the syllabus by looking at commercial banks. This week, the lesson's focus is the central bank. The final part of this lesson will look at the relationship between the two financial institutions.

Central banks also form a part of the financial sector. A central bank is a financial institution which has, as its main function, the carrying out of government's monetary policies.

Central banks may be privately owned, owned by the government or by private individuals and the government. Regardless of ownership, a central bank works very closely with the government and its functions are the same.

Central banks are usually named after the country in which they exist, for example, Bank of Jamaica is Jamaica's central bank and Bank of England is England's central bank and Bank of France is France's central bank. The Bank of Jamaica has two branches, the main one in Kingston at Nethersole Place and a branch in Montego Bay.

Functions of central banks

DOMESTIC FUNCTIONS

1. Carrying out governments monetary policies

These policies have to do either with the expansion or contraction of the money supply and include policies regarding interest rates, credit restrictions, cash reserve ratios, etc.

2. Regulation of the banking system

Commercial banks and some other financial institutions are monitored to ensure that they adhere to the monetary policies of the government and that they act responsibly.

3. Issues notes and coins and re-calls them from circulation

This is done based on the instructions of the government.

4. Acts as banker to the government and commercial banks

In carrying out this function, the central bank behaves like a typical commercial bank, accepting deposits, safeguarding them and lending money to the government and commercial banks. The government and commercial banks are the customers of the central bank.

5. Manages the national debt

When the government needs to borrow to balance its budget, the central bank arranges for the sale of government bonds and treasury bills. When these bills and bonds mature, the central bank repays them with interest. Records are kept at the central bank regarding the national debt.

6. Lender of last resort

The commercial banks and the government will borrow money from the central bank, but only as a last resort, that is when all other avenues have failed. This is because the interest rates of the central bank tend to be higher than elsewhere.

7. Helps businesses

Central banks sometimes provide businesses with their FIXED capital.

8. Keeps the country's gold reserves

9. Offers financial advice

This is given to commercial banks and the government in the same way that commercial banks give advice to their customers.

10. Clearing house for banks

This means that cheques drawn on commercial banks are cleared on a daily basis at the central bank. Thus, the central bank is a part of the whole process of making the cheque available, and for it to be effectively used.

INTERNATIONAL FUNCTIONS

1. Negotiates in international loan agreements

Included in such agreements are, for example, the International Monetary Fund, World Bank, and other international donor agencies and countries.

2. Manage the country's foreign exchange reserves

This means that they enforce foreign exchange controls and regulate the issuing of foreign exchange and the setting and publishing of foreign exchange rates for various currencies in relation to local currencies.

Relationship between central banks and commercial banks

As seen in the outline of the functions above, the central bank acts as banker to the commercial banks and also regulates them, ensuring that they operate efficiently, and do not exploit their customers and that they carry out governments' monetary policies. In acting as banker, they carry out many of the functions that commercial banks carry out, for their customers and, in ensuring that they carry out government's monetary policies, they set base interest rates and other guidelines for them to follow.

Now tackle this question

(a) Define the term central bank. (2 marks)

(b) Name TWO central banks. (2 marks)

(c) Who are the owners of central banks? (2 marks)

(d) Describe FOUR functions of a central bank. (8 marks)

(e) Discuss TWO aspects of the relationship between central banks and commercial banks (6 marks)

Total marks: 20

Next week, we will discuss personal budgeting. This is quite an interesting topic, especially in these financially difficult times. Bye for now.

L'Acadco dancers honour the president of the United Republic of Tanzania at the Little Theatre on Tuesday, November 24. - Colin Hamilton/Freelance Photographer

Yvonne Harvey teaches at Glenmuir High School. Send questions and comments to kerry-ann.hepburn@gleanerjm.com