Finance Paper: Roles and Functions of Central Bank

finance-paper-roles-and-functions-of-central-bank

“Like any other central bank, Canada’s central bank, the Bank of Canada, has the following purposes. It controls the growth of the money supply; acts as a banker for the government of Canada and Canadian chartered banks; act as a lender of last resort; and administers and regulates the orderly buying and selling of Canadian dollars in the foreign exchange market. In case of Canada, the Bank Act enables the Bank of Canada to fulfill its functions.

Next, I will elaborate on how Central Banks affect the monetary policy. They can affect back deposits by open market purchase and sale operations in bonds and/or treasury bills. If the chartered bank’s deposits are reduced, they must either reduce lending operations; sell off their investments to raise money; increase deposit by offering higher interest rates to their customers; or borrow from other chartered banks or the Central Bank.

Further, the Central Bank uses the control over the fiscal policy to affect the financial system in at least two major ways. As an example of the stabilization function of the fiscal policy, when there is recession the revenue of the federal government goes down, the central bank can two course of action. If recession causes federal government deficit, the central bank can borrow in the financial markets, squeezing out other borrowers of lower equity. Thus, the other borrowers will have to pay more for the money that is available or they will have to go without it. If the central bank decides not to borrow, it will either raise taxes or print money.

Next, we will explore the role of the central bank in the mergers and acquisitions in the context of the Danish banking sector during a financial crisis. A classic example would be of the Roskilde Bank, which was a victim of risky investment in the rapidly expanding real estate market. They had created a large deposit deficit where a large amount of depreciations that put the bank in a very undesirable position. It sought the help of the Danish Central Bank due to their insufficient liquidity. In the year 2008, the Roskilde Bank was declared insolvent, and to bail it out the central bank decided to acquire it. This was an unprecedented situation in the history of the Danish central banking system. They took this unprecedented step to avoid a total meltdown of the trust of people in their banking system. Later, the central bank facilitated the take-over of a few of their branches by three other chartered banks. Further, taking an example from India, we evaluate the role of their central bank in regulation of bank merger. There a legislation is being proposed to exclude the role of the competition regulator and making the bank merger an exclusively under the central bank. The central bank in India is known as the Reserve Bank of India. In contrast, in the US and in the EU, the bank mergers have been in increasingly scrutiny of the competition regulators. In these countries there is a general belief that the banking sector must adhere to the general rules of competition and cannot be given any special privileges. Therefore, the legislation in India is being seen as moving in the opposite direction from the rest of the world.

In conclusion, we can say with a great degree of certainty that central banks, besides the traditional role of regulating the monetary and fiscal policy of the country, have to take innovative and unprecedented steps for the health of the economy. Nothing can be best exemplified by the Danish and the Indian examples. One where they themselves bought over a chartered bank and another where they went against the principles of healthy competition.

References

Cyr, D., Kahl, A. L., Rentz, W. F., Moyer, R. C., McGuigan, J. R., & Kretlow, W. J. (2004). The Domestic and Global Financial Marketplace. In D. Cyr, A. L. Kahl, W. F. Rentz, R. C. Moyer, J. R. McGuigan, & W. J. Kretlow, Contemporary Financial Management (pp. 31-33). Toronto: Thomson Nelson.

Jorgensen, V. B., & Jorgensen, I. B. (2010). The Importance of Mergers & Acquisitions within the Danish banking sector during a financial crisis. Aarhus: Aarhus University. Retrieved from http://pure.au.dk/portal/files/10545/BA__pdf.pdf

Mukherjee, A. (2013). Analysing the Role of the Central Bank in Bank Merger Regulation in India: A Scrutiny from the US and the EU Perspectives. World Competition, 165-183. Retrieved from http://www.kluwerlawonline.com/abstract.php?area=Journals&id=WOCO2013008″

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