Central bank vs Commercial bank

Thomas Sim PEA2066

Q.
b) Differentiate the functions of commercial banks and central bank. (10 marks)

(10 marks, 2011 Q7b)

A.

A central bank is a banker's bank. It is normally part of or connected to the government of a country and manages the country's financial system. A commercial bank provides banking services to businesses, institutions and some individuals. The money it takes in from its customers is deposited at its local central bank. Nearly all the country's banks have accounts at the central bank to keep their money and for borrowing to offset any temporary shortages of cash. Nearly every country in the world has a central bank. The Federal Reserve Bank, or Fed, is the central bank for the United State of America. Bank Negara Malaysia (BNM) is the central bank of Malaysia,

Deposits

Both commercial banks and central banks take in deposits of money. Commercial banks receive their deposits, in the form of checking, savings and certificates of deposit, from their corporate or individual customers and deposit that money at their country's central bank. Commercial banks serve individuals and businesses, while central banks serve the country's banking system, providing money transfers back and forth between banks and governmental institutions both domestically and in cases of transactions with foreign entities. Commercial banks normally have branches in different parts of their region. Central banks maintain regional branch banks throughout the country.

Loans

Commercial banks lend out the money they take in deposits. They make personal loans, auto loans, business loans and mortgages. Occasionally, they will take in less money than they need to cover the loans they make, so their books will show a negative balance. To cover the cash shortfall, commercial banks borrow from their central banks.

The central bank controls monetary policy of the country. The Fed can inject more cash into the banking system by printing more money, and buy back securities from the commercial banks. It can reduce cash in the system by issuing securities, and commercial banks would buy these securities and put money in the central bank. Thus, circulating cash would be less.

The Central banks also control the interest rates for loans, and regulated the ratio of how much liquid cash should a bank maintain in its deposits - the appropriate reserves required (fractional reserve banking). The central bank also plays the role of as a regulatory agency and monitor the activities of the commercial banks.

Ref:

http://smallbusiness.chron.com/list-major-differences-between-central-bank-commercial-bank-3716.html

Functions of a central bank may include:
  • implementing monetary policies.
  • determining Interest rates
  • controlling the nation's entire money supply
  • the Government's banker and the bankers' bank ("lender of last resort")
  • managing the country's foreign exchange and gold reserves and the Government's stock register
  • regulating and supervising the banking industry
  • setting the official interest rate – used to manage both inflation and the country's exchange rate – and ensuring that this rate takes effect via a variety of policy mechanism
Ref: