makes your trading easier
Popular links:
Currency codes
Forex glossary of terms
Forex FAQ's
Currency forwards
Currency futures
Currency options
Currency swaps

Home  >  Fundamental analysis  >  World central banks

World central banks

Parts of this topic:

A central bank is a financial institution established by a national government for the purpose of regulating the monetary policies of that country.

There is no standard terminology for the name of a central bank, but many countries use the "Bank of Country" form (e.g., Bank of England, Bank of Canada, Bank of Russia). Some are styled national banks, such as the National Bank of Ukraine. In many countries, there may be private banks that incorporate the term national. Many countries have state-owned banks or other quasi-government entities that have entirely separate functions, such as financing imports and exports.

In some countries, particularly in some Communist countries, the term national bank may be used to indicate both the monetary authority and the leading banking entity, such as the USSR's Gosbank (state bank). In other countries, the term national bank may be used to indicate that the central bank's goals are broader than monetary stability, such as full employment, industrial development, or other goals.

Central banks have a wide range of responsibilities - from overseeing monetary policy to implementing specific goals such as currency stability, low inflation and full employment. Central banks also generally issue currency, function as the bank of the government, regulate the credit system, oversee commercial banks, manage exchange reserves and act as a lender of last resort.

Functions of a central bank (not all functions carried out by all banks):

  • implementing the basis of monetary policy
  • monopoly on the issue of banknotes
  • the Government's banker and the bankers' bank ("Lender of Last Resort")
  • manages the country's foreign exchange and gold reserves and the Government's stock register;
  • regulation and supervision of 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 mechanisms.

A typical central bank has several interest rates or monetary policy tools it can set to influence markets.

  • Marginal Lending Rate (currently 4.25% in the Eurozone) A fixed rate for institutions to borrow money from the CB.
  • Main Refinancing Rate (3.25% in the Eurozone) This is the publicly visible interest rate the central bank announces. It is also known as Minimum Bid Rate and serves as a bidding floor for refinancing loans (In the US this is called the Discount rate).
  • Deposit Rate (2.25% in the Eurozone) The rate parties receive for deposits at the CB.

These rates directly affect the rates in the money market, the market for short term loans.

Open Market Operations

Small economies with little control over users of their currency, and the US which due to the use of its currency worldwide also has little control, and the EU which can't easily control policies of all national banks, tend to employ open market operations rather than Chinese-style reserve rulings.

Through open market operations, a central bank influences the money supply in an economy directly. Each time it buys securities, exchanging money for the security, it raises the money supply. Conversely, selling of securities lowers the money supply. Buying of securities thus amounts to printing new money while lowering supply of the specific security.

The main open market operations are:

  • Temporary lending of money for collateral securities ("Reverse Operations" or " repurchase operations", otherwise known as the "repo" market). These operations are carried out on a regular basis, where fixed maturity loans (of 1 week and 1 month for the ECB) are auctioned off.
  • Buying or selling securities ("Direct Operations") on ad-hoc basis.
  • Foreign exchange operations such as forex swaps.

All of these interventions can also influence the foreign exchange market and thus the exchange rate. For example the People's Bank of China and the Bank of Japan have on occasion bought several hundred billions of U.S. Treasuries, presumably in order to stop the decline of the U.S. dollar versus the Renminbi and the Yen.

All banks are required to hold a certain percentage of their assets as capital, a rate which may be established by the central bank or the banking supervisor.

Another significant power that central banks hold is the ability to establish reserve requirements for other banks. By requiring that a percentage of liabilities be held as cash or deposited with the central bank (or other agency), limits are set on money supply.

In practice, many banks are required to hold a percentage of their deposits as reserves. Such legal reserve requirements were introduced in the nineteenth century to reduce the risk of banks overextending themselves and suffering from bank runs, as this could lead to knock-on effects on other banks.

To influence the money supply, some central banks may require that some or all foreign exchange receipts (generally from exports) be exchanged for the local currency. The rate that is used to purchase local currency may be market-based or arbitrarily set by the bank.

There is a difference between two types of central bank: the autonomous and the semi-autonomous.

The autonomous bank is politically and financially independent. Its Governor is appointed for a period which is longer than the periods of the incumbent elected politicians, so that he will not be subject to political pressures. Its budget is not provided by the legislature or by the executive arm. It is self sustaining: it runs itself as a corporation would. Its profits are used in leaner years in which it loses money (though for a central bank to lose money is a difficult task to achieve).

Prime examples of autonomous central banks are Germany's Bundesbank and the American Federal Reserve Bank.

The second type of central bank is the semi autonomous one. This is a central bank that depends on the political echelons and, especially, on the Ministry of Finance. This dependence could be through its budget which is allocated to it by the Ministry or by a Parliament (ruled by one big party or by the coalition parties).

The upper levels of the bank - the Governor and the Vice Governor - could be deposed of through a political decision (albeit by Parliament, which makes it somewhat more difficult). This is the case of the National Bank of Macedonia which has to report to Parliament. Such dependent banks fulfil the function of an economic advisor to the government. The Governor of the Bank of England advises the Minister of Finance (in their famous weekly meetings, the minutes of which are published) about the desirable level of interest rates.

Central banks are usually made up of a board of directors or governors who have periodic meetings to discuss their countrys economic outlook and set monetary policy. The board members in the United States are appointed by the President and are accountable to Congress. They enjoy a degree of independence from political considerations such as what policies are popular with the electorate.

The inner workings of most central banks are shrouded in secrecy; the policy-making meetings are closed to the press. In the United States, high-ranking members of the central bank rarely give press interviews.

The central bank has a large research staff which investigates current topics in the economy and monetary policy and sometimes does historical analysis. Their reports are closely followed and carry great weight in the economic community and often make terrific analytic stories for a central bank reporter. Try to follow the central banks research as closely as possible and line up interviews with research economists on their areas of expertise.

Many central bank research departments put out periodic forecasts on major economic indicators. These are important stories because a forecast can also be seen as a target and can indicate what the central bank sees as the most desirable levels for inflation, growth and employment.

A central bank reporter should closely follow the statements and speeches of key central bank officials for any hints on the direction of policy or assessments of the economy. Whenever possible, try to obtain exclusive interviews with officials or economists at the central bank to learn more about the inner workings of this powerful institution.

Two of the earliest central or government-sponsored banks are the Riksbank of Sweden, which was founded in 1668, and the Bank of England, which began in 1694. The Riksbank, which did not acquire its present name until 1867, did not originally function as central banks do today. It started as a public bank but one with a unique relationship to the Swedish state. The Swedish parliament in fact had sole governing rights over operations of the Bank of the Estates of the Realm, as it was then called. The Riksbank evolved, like many central banks of other countries, because the national government was its biggest customer.

The Bank of England was created solely to finance England's Nine Years' War with France. Instrumental in the creation of the bank was William Paterson (1658-1719), a man familiar with banking practices on the European continent. Paterson received financial backing for his plan to create a national bank from a group of wealthy London merchants. These merchants feared that their Protestant king would accede to Catholic France because of a lack of funds in the English war chest.

Paterson arranged a loan to the government to finance the war effort and the merchants who subscribed to the loan incorporated as the Governor and Company of the Bank of England. This was the first bank to be capitalized by public subscription and was granted special privileges including handling of the government's financial accounts. The bank's charter went into effect on July 27, 1694, and the bank opened for business a few days later.

The United States was one of the last contemporary economic powers to found a central bank. The central banking authority in the United States is the Federal Reserve System, which wasn't founded until 1913.

The world's newest central bank is the European Central Bank (ECB). The ECB was created to serve as the independent bank of the European Union.

Site map | Contact us

© 2006—2018 Forextheory