Central Bank

We all keep money or cash in our pockets or wallets, in the drawers or boxes of our homes, or in banks. This money is printed by the country's central bank and made available for circulation through various banks.

In the context of Nepal, Nepal Rastra Bank was established as the central bank on April 26, 1957, under the Nepal Rastra Bank Act 2012.

According to economist Vera Smith, "The primary definition of central banking is a banking system in which a single bank has either a complete or residuary monopoly of note issue."

The central bank is the central monetary institution of the country. It controls money and credit in the economy and plays an important role as an economic advisor to the government for economic development.

Functions of Central Bank

Central banks are established in every country to perform monetary, banking, and financial functions. The functions performed by Nepal Rastra Bank as the central bank can be explained as follows:

1. Note Issuance

The money or notes we use daily are issued by Nepal Rastra Bank as the country's central bank.

Nepal Rastra Bank has a monopoly on issuing different denominations of notes required in Nepal. Therefore, this bank is also called the note-issuing bank.

While issuing notes, the bank considers:

• The demand for money in the country.

• The price stability of goods in the market.

According to the proportional reserve system, Nepal Rastra Bank must keep:

• 50% of the value of issued notes in gold and silver.

• 50% in foreign currency, foreign securities, and bills of exchange in its reserves.

Nepal Rastra Bank started issuing notes in 1959. Currently, it issues notes of Rs. 5, Rs. 10, Rs. 20, Rs. 50, Rs. 100, Rs. 500, and Rs. 1000.

2. Bank of Banks

The central bank grants permission to establish commercial banks and financial institutions according to the country's needs.

Commercial banks and financial institutions have a close relationship with the central bank, just like a parent and child.

The central bank:

• Grants them permission to open branches.

• Supervises their financial transactions.

• Provides loan assistance as needed.

• Accepts their deposits.

All banks and financial institutions must follow the policies, directives, and suggestions issued by the central bank.

When banks face a financial crisis, the central bank provides:

• Financial support

• Technical support

• Policy support

This is why the central bank is also called the "bank of all banks" and financial institutions.

3. Lender of Last Resort

The central bank acts as the lender of last resort for commercial banks.

Commercial banks must deposit a portion of their cash in the central bank. However, banks and financial institutions invest in various sectors, and sometimes, they might not have sufficient cash reserves.

If a bank faces a liquidity crisis and cannot solve the issue on its own, it can borrow money from the central bank.

This is why the central bank is considered the "lender of last resort".

4. Credit Control

The primary function of commercial banks and financial institutions is to create credit.

Since these banks aim to maximize profits, they try to issue as many loans as possible. However, this can lead to an excessive increase in credit in the market.

If too much credit is created, it causes inflation.

Both situations can harm economic stability.

To control the money supply and credit, Nepal Rastra Bank uses monetary policy instruments, such as:

• Bank rate policy

• Open market operations

• Credit limit policy

• Interest rate adjustments

These measures help to maintain economic stability.

5. Government Advisor, Representative, and Banker

The central bank serves as an economic and financial consultant to the government.

It provides necessary advice and suggestions for formulating:

• Financial policy

• Monetary policy

• Industrial policy

• Commercial policy

As a representative of the government, the central bank also:

• Buys and sells government securities.

• Collects government revenue.

• Pays principal and interest on government debt.

• Buys and sells foreign securities.

As the government’s banker, the central bank also:

• Raises short-term and long-term loans for the government.

• Provides special loans during emergencies.

This is why the central bank is also called the "government’s bank".

6. Foreign Exchange and Economic Development

Apart from its major functions, the central bank also plays a key role in foreign exchange management and economic development.

It is responsible for:

• Managing the income and expenditure of all foreign currencies.

• Determining and managing the exchange rate of foreign currencies with Nepalese currency.

• Protecting gold and foreign currency reserves received from various sources.

Additionally, as a driver of economic development, the central bank:

• Facilitates the establishment of new financial institutions.

• Supports the government in development activities.

• Maintains good relations with international financial institutions.

• Helps in the monetization of the economy.

Thus, the central bank serves as the backbone of a country’s financial system.