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Central Bank – Evolution

In Europe prior to the 17th century most money was commodity money, typically gold or silver. However, promises to pay were widely circulated and accepted as value at least five hundred years earlier in both Europe and Asia. The medieval European Knights Templar ran probably the best known early prototype of a central banking system, as their promises to pay were widely regarded, and many regard their activities as having laid the basis for the modern banking system. At about the same time, Kublai Khan of the Mongols introduced fiat currency to China, which was imposed by force by the confiscation of specie. As the first public bank to “offer accounts not directly convertible to coin”, the Bank of Amsterdam established in 1609 is considered to be the “first true central bank”. This was followed in 1694 by the Bank of England, created by Scottish businessman William Paterson in the City of London at the request of the English government to help pay for a war.

Although central banks are generally associated with fiat money, under the international gold standard of the nineteenth and early twentieth centuries central banks developed in most of Europe and in Japan, though elsewhere free banking or currency boards were more usual at this time. Problems with collapses of banks during downturns, however, were leading to wider support for central banks in those nations which did not as yet possess them, most notably in Australia.

With the collapse of the gold standard after World War II, central banks became much more widespread. The US Federal Reserve was created by the U.S. Congress through the passing of the Glass-Owen Bill, signed by President Woodrow Wilson on December 23, 1913, whilst Australia established its first central bank in 1920, Colombia in 1923, Mexico and Chile in 1925 and Canada and New Zealand in the aftermath of the Great Depression in 1934. By 1935, the only significant independent nation that did not possess a central bank was Brazil, which developed a precursor thereto in 1945 and created its present central bank twenty years later. When African and Asian countries gained independence, all of them rapidly established central banks or monetary unions.


A central bank, reserve bank, or monetary authority is a banking institution granted the exclusive privilege to lend a government its currency. Like a normal commercial bank, a central bank charges interest on the loans made to borrowers, primarily the government of whichever country the bank exists for, and to other commercial banks, typically as a 'lender of last resort'. However, a central bank is distinguished from a normal commercial bank because it has a monopoly on creating the currency of that nation, which is loaned to the government in the form of legal tender. It is a bank that can lend money to other banks in times of need. Its primary function is to provide the nation's money supply, but more active duties include controlling subsidized-loan interest rates, and acting as a lender of last resort to the banking sector during times of financial crisis (private banks often being integral to the national financial system). It may also have supervisory powers, t ensure that banks and their financial institutions do not behave recklessly or fraudulently.

Functions of Central Bank

The important functions of Central Banks are as flows:

  1. Sole Right of Note Issue: The Central Bank in every country, now, has the monopoly note issue. The issue of notes is governed by certain regulation which is enforced by the state.
  2. Banker to the State : A Central Bank acts as a banker to the government. It holds cash balances of the government free of interest.
  3. Banker's Bank: The central bank acts as a banker to the commercial banks.
  4. Banker's Clearing House: The Central Bank acts as a clearing house for the settlement of mutual obligations of different commercial banks. If a difference exists, it is paid by a cheque drawn on the banks accounts carried at the Central Bank.
  5. Lender to the Last Resort: The Central Bank helps the member banks in times of crisis.
  6. Financial Agent: The Central Banks act as financial agents for the government. It is an agent for the government in purchasing and selling of gold and foreign exchange.
  7. Effective Monetary Policy: The aim of the government is to create employment in the country, resist undue inflation and achieve a favorable balance of payment.

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