02/01/2023
When you think about a bank, perhaps the first thing that pops into your mind is the place where you manage your finances through services and products like deposits and loans. However, there is a financial institution that doesn't have a commercial focus but that plays a key role in the economy and that is also called a bank: a central bank.
A central bank is a public institution that is responsible for implementing monetary policy, managing the currency of a country, or group of countries, and controlling the money supply. Some of the main responsibilities central banks have are:
- Defining monetary policy – central banks set macroeconomic objectives such as to ensure price stability and economic growth. To do this, financial authorities have tools like setting official interest rates, which have an impact on the cost of money. Based on the economic situation, central banks will opt to either increase official interest rates (to control inflation, for example) or decrease them (to encourage consumption and boost economic growth).
- Regulating money in circulation – they are the authority for issuing coins and notes, the money supply, and for regulating how much money is in circulation. Central banks do this to inject liquidity into the economy so that different economic agents (families, companies and States) can use it in their transactions. With regard to currencies, central banks are also responsible for carrying out operations to ensure that exchange rates remain stable, as well for owning and controlling their official reserves.
- Overseeing the inter-bank market – they ensure that the relevant financial laws are respected and they monitor national payment systems to make sure that they are working properly.
- Loaning liquidity to commercial banks if necessary for solvency issues – aside from the loans made between institutions in the inter-bank market, as mentioned in the previous bullet point, commercial banks can also receive liquidity from central banks in exchange for collateral, such as guaranteed public bonds. This means that, if required, commercial banking institutions can cover what they need in the short-term, while the central banks try and ensure price stability by mediating in credit fluctuations.
- Taking on an advisory role – they regularly produce studies and reports that are useful for governments or private organizations, for example.
Central banks do all of this independently of the political group in power in any given country, as they aim to ensure the stability of the financial system. Their decisions are directly dependent on the supervisory body that composes the financial institution.
What central banks are there?
Central banks represent a country's financial institution but they can also represent a group of them. The eurozone is an example of a financial institution made up of a group of countries. In this case, the power falls under the Eurosystem, which is made up of two fundamental parts: the European Central Bank (ECB) and the national central banks of the eurozone's member states that have the euro as their official currency. The Bank of Spain, the Deutsche Bundesbank and the National Bank of Poland (Narodowy Bank Polski, NBP) are some examples.
As there are some countries that are part of the European Union but not part of the eurozone, in addition to the Eurosystem there is also another organisation called the European System of Central Banks (ESCB). This is made up of both the European Central Bank and all the national central banks of the countries that make up the European Union, whether they have the euro as their official currency or not.
In the United States, the Federal Reserve System is the central banking system there. Known simply as the Fed, it is responsible for carrying out the aforementioned tasks to watch over the country's economy and currency – in this case the dollar.
Also in the Americas, other examples of central banks are Banxico, for Mexico and Banco Central do Brasil for Brazil.
