4.4.3 - Role of central banks

Implementation of monetary policy

• Controls monetary policy through interest rates and controlling money supply, in order to keep inflation low and stable

Banker to the government

• They often hold the government’s bank account and lend to them, holding government debt, as well as holding gold and foreign exchange reserves

• However, the exact nature of the services offered by the bank differs from country to country

Banker to the banks - lender of last resort

• If banks experience liquidity problems, they can sell their illiquid assets or take a loan from the central bank

• If a bank is about to collapse because its assets have fallen too far in value (e.g. Financial Crisis 2008), then the central bank can lend the them money to prevent them from collapsing

Role in the regulation of the banking industry

• Some central banks regulate the financial system - important to prevent financial institutions from undertaking activities which harm consumers or engage in risky activities which could lead to collapse and to prevent systemic risk

Examples of financial regulation

• Banning market rigging

• Preventing the sale of unsuitable products

• Maximum interest rates to prevent consumer exploitation and prevent excessively risky lending

• Deposit insurance to protect consumer deposits and increase stability

• Liquidity ratios - banks are forced to hold a certain percentage of liquid assets