What is a Central Reserve Bank?

What did I want to do?

• I wanted my kids Ash (12 years old) and Adh (10 years old) to understand the role of central reserve banks in an economy.
• I wanted to use this opportunity to explore concepts such as interest rates, inflation and printing money.
• We have already gone through the role of banks and how they make money.

What is a Central Reserve Bank?

Some countries call this a Central Bank. Some countries call this a Reserve Bank. Essentially, both refer to the same - a governing entity that defines the rules and regulations that need to be followed by the banks of that country. In addition to regulating the banks in the country, the Central Reserve Bank also defines monetary policies & laws and decides on interest rates.

One of the key functions of the Central Reserve Bank is to monitor the banks and enforce rules and regulations to ensure that banks don't go bust.

Can banks go bust?

Yes. That's a scary situation.

Let me explain.

We have already seen how banks make money. Essentially, funders deposit money in the bank, and the bank then lends money to the borrowers at a higher interest rate.

There are a couple of scenarios that we could discuss where the banks may not have enough money to pay back the funders:

• What if all the funders suddenly go to the bank and ask for their money back? If all the funders ask for their money back, the bank will not have money to pay back - because they have already lent the money to the borrowers.
• What if the investments fail? Banks also invest in other companies to get higher returns. The banks won't have enough money to repay lenders or borrowers if their investments fail.
• What if the bank owner takes all the money and runs away?
• ... there could be more.

What are the key functions of the Central Reserve Bank?

The primary function of the Central Reserve Bank is to keep its country’s economy and financial system stable.

They can increase or decrease the money supply through monetary policies. Controlling interest rates helps keep and maintain:

• low unemployment,
• stable prices, and
• low inflation.

Regulating banks, including specifying the cash reserves the banks should maintain, ensures that there is no misconduct and that people’s money is safe.

The Central Reserve Bank also acts as a lender (in case of emergency situations) and helps companies and even governments stay out of bankruptcy, which makes the country’s financial system more stable.

The Central Reserve Bank can do the following:

• print money
• manage foreign exchange reserves
• advise governments on financial policy
• monitor the exchange of transfers between banks
• ... and more

Next Step

Let's look at:

• Why invest?
• Central Reserve Banks
• Cash Rate