Central bank

A central bank, reserve bank, or monetary authority is an institution that manages a state's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and usually also prints the national currency,[1] which usually serves as the state's legal tender. Central banks also act as a "lender of last resort" to the banking sector during times of financial crisis. Most central banks usually also have supervisory and regulatory powers to ensure the solvency of member institutions, prevent bank runs, and prevent reckless or fraudulent behavior by member banks.

Central banks in most developed nations are institutionally designed to be independent from political interference.[2][3] Still, limited control by the executive and legislative bodies usually exists.[4][5]

History

Early history

The use of money as accounting unit predates history. Government control of money is documented in the ancient Egyptian economy (2750-2150 BC).[6] The Egyptians measured the value of goods with a central unit called shat. As many other currencies, the shat was linked to gold. The value of a shat in terms of goods was defined by government administrations. Other cultures in Asia Minor later materialised their currencies in the form of gold and silver coins.[7]

In the medieval and the early modern period a network of professional banks was established in Southern and Central Europe.[8] The institutes built a new tier in the financial economy. The monetary system was still controlled by government institutions, mainly through the coinage prerogative. Banks, however, could use book money to create deposits for their customers. Thus, they had the possibility to issue, lend and transfer money autonomously without direct governmental control.

In order to consolidate the monetary system, a network of public exchange banks was established at the beginning of the 17th century in main European trade centres. The Amsterdam Wisselbank was founded as a first institute in 1609. Further exchange banks were located in Hamburg, Venice and Nuremberg. The institutes offered a public infrastructure for cashless international payments.[9] They aimed to increase the efficiency of international trade and to safeguard monetary stability. The exchange banks thus fulfilled comparable functions to modern central banks.[10] The institutes even issued their own (book) currency, called Mark Banco.

Bank of Amsterdam (Amsterdamsche Wisselbank)

The old town hall in Amsterdam where the Bank of Amsterdam was founded in 1609, painting by Pieter Saenredam.

In the early modern period, the Dutch were pioneering financial innovators who developed many advanced techniques and helped lay the foundations of modern financial system.[11][12][13][14] The Bank of Amsterdam (Amsterdam Wisselbank), established in the Dutch Republic in 1609, is often considered to be a forerunner to modern central banks.[15][16][17] The Wisselbank's innovations helped lay the foundations for the birth and development of the central banking system that now plays a vital role in the world's economy.[18][19][20][21] Along with a number of subsidiary local banks, it performed many functions of a central banking system.[22] It occupied a central position in the financial world of its day, providing an effective, efficient and trusted system for national and international payments, and introduced the first ever international reserve currency, the bank guilder.[23] Lucien Gillard (2004) calls it the European guilder (le florin européen),[24] and Adam Smith devotes several pages to explaining how the bank guilder works (Smith 1776: 446-455). The model of the Wisselbank as a state bank was adapted throughout Europe, including the Bank of Sweden (1668) and the Bank of England (1694).

Bank of Sweden (Sveriges Riksbank)

Established by Dutch-Latvian Johan Palmstruch in 1668, Sveriges Riksbank (Bank of Sweden) is often considered by many as the world's oldest central bank.

Bank of England

Sealing of the Bank of England Charter (1694), by Lady Jane Lindsay, 1905.

The establishment of the Bank of England, the model on which most modern central banks have been based, was devised by Charles Montagu, 1st Earl of Halifax, in 1694, following a proposal by the banker William Paterson three years earlier, which had not been acted upon.[25] In the Kingdom of England in the 1690s, public funds were in short supply, and the credit of William III's government was so low in London that it was impossible for it to borrow the £1,200,000 (at 8 percent) needed to finance the ongoing Nine Years' War with France. In order to induce subscription to the loan, Montagu proposed that the subscribers were to be incorporated as The Governor and Company of the Bank of England with long-term banking privileges including the issue of notes. The lenders would give the government cash (bullion) and also issue notes against the government bonds, which could be lent again. A Royal Charter was granted on 27 July through the passage of the Tonnage Act 1694.[26] The bank was given exclusive possession of the government's balances, and was the only limited-liability corporation allowed to issue banknotes.[27][page needed] The £1.2M was raised in 12 days; half of this was used to rebuild the Navy.

The Bank of England, established in 1694.

Although this establishment of the Bank of England marks the origin of central banking, it did not have the functions of a modern central bank, namely, to regulate the value of the national currency, to finance the government, to be the sole authorised distributor of banknotes, and to function as a 'lender of last resort' to banks suffering a liquidity crisis. These modern central banking functions evolved slowly through the 18th and 19th centuries.[28]

Although the Bank was originally a private institution, by the end of the 18th century it was increasingly being regarded as a public authority with civic responsibility toward the upkeep of a healthy financial system. The currency crisis of 1797, caused by panicked depositors withdrawing from the Bank led to the government suspending convertibility of notes into specie payment. The bank was soon accused by the bullionists of causing the exchange rate to fall from over issuing banknotes, a charge which the Bank denied. Nevertheless, it was clear that the Bank was being treated as an organ of the state.[citation needed]

Henry Thornton, a merchant banker and monetary theorist has been described as the father of the modern central bank. An opponent of the real bills doctrine, he was a defender of the bullionist position and a significant figure in monetary theory. Thornton's process of monetary expansion anticipated the theories of Knut Wicksell regarding the "cumulative process which restates the Quantity Theory in a theoretically coherent form". As a response to the 1797 currency crisis, Thornton wrote in 1802 An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, in which he argued that the increase in paper credit did not cause the crisis. The book also gives a detailed account of the British monetary system as well as a detailed examination of the ways in which the Bank of England should act to counteract fluctuations in the value of the pound.[29]

Walter Bagehot, an influential theorist on the economic role of the central bank.

Until the mid-nineteenth century, commercial banks were able to issue their own banknotes, and notes issued by provincial banking companies were commonly in circulation.[30] Many consider the origins of the central bank to lie with the passage of the Bank Charter Act of 1844.[28] Under this law, authorisation to issue new banknotes was restricted to the Bank of England. At the same time, the Bank of England was restricted to issue new banknotes only if they were 100% backed by gold or up to £14 million in government debt. The Act served to restrict the supply of new notes reaching circulation, and gave the Bank of England an effective monopoly on the printing of new notes.[31]

The Bank accepted the role of 'lender of last resort' in the 1870s after criticism of its lacklustre response to the Overend-Gurney crisis. The journalist Walter Bagehot wrote on the subject in Lombard Street: A Description of the Money Market, in which he advocated for the Bank to officially become a lender of last resort during a credit crunch, sometimes referred to as "Bagehot's dictum". Paul Tucker phrased the dictum in 2009 as follows:

…to avert panic, central banks should lend early and freely (ie without limit), to solvent firms, against good collateral, and at 'high rates'.[32]

Spread around the world

Central banks were established in many European countries during the 19th century. The War of the Second Coalition led to the creation of the Banque de France in 1800, in an effort to improve the public financing of the war.

Although central banks today are generally associated with fiat money, the 19th and early 20th centuries central banks in most of Europe and Japan developed under the international gold standard, elsewhere[where?] free banking or currency boards were more usual at this time. Problems with collapses of banks during downturns, however, led to wider support for central banks in those nations which did not as yet possess them, most notably in Australia.

On 23 December 1913 the U.S. Congress created the US Federal Reserve through the passing of The Federal Reserve Act in the Senate and its signing by President Woodrow Wilson on the same day. Australia established its first central bank in 1920, Peru in 1922, Colombia in 1923, Mexico and Chile in 1925 and Canada, India 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 subsequently developed a precursor thereto in 1945 and the present Central Bank of Brazil twenty years later. After gaining independence, African and Asian countries also established central banks or monetary unions. The Reserve Bank of India, which had been established during British colonial rule as a private company, was nationalized in 1949 following India's independence.

The headquarters of the People's Bank of China in Beijing.

The People's Bank of China evolved its role as a central bank starting in about 1979 with the introduction of market reforms, which accelerated in 1989 when the country adopted a generally capitalist approach to its export economy. Evolving further partly in response to the European Central Bank, the People's Bank of China had by 2000 become a modern central bank. The most recent bank model was introduced together with the euro, and involves coordination of the European national banks, which continue to manage their respective economies separately in all respects other than currency exchange and base interest rates.

Naming of central banks

There is no standard terminology for the name of a central bank, but many countries use the "Bank of Country" form — for example: Bank of England (which, despite its name, is in fact the central bank of the United Kingdom as a whole. The name's lack of representation of the entire United Kingdom ('Bank of Britain', for example) can be owed to the fact that its establishment occurred when the Kingdoms of England, Scotland and Ireland were separate entities (at least in name), and therefore pre-dates the merger of the Kingdoms of England and Scotland, the Kingdom of Ireland's absorption into the Union and the formation of the present day United Kingdom), Bank of Canada, Bank of Mexico, Bank of Thailand.

The word "Reserve" is also often included, such as the Reserve Bank of India, Reserve Bank of Australia, Reserve Bank of New Zealand, the South African Reserve Bank, and Federal Reserve System. Other central banks are known as monetary authorities such as the Saudi Arabian Monetary Authority, Hong Kong Monetary Authority, Monetary Authority of Singapore, Maldives Monetary Authority and Cayman Islands Monetary Authority. There is an instance where native language was used to name the central bank: in the Philippines the Filipino name Bangko Sentral ng Pilipinas is used even in English.

Some are styled "national" banks, such as the Swiss National Bank, National Bank of Poland and National Bank of Ukraine, although the term national bank is also used for private commercial banks in some countries such as National Bank of Pakistan. In other cases, central banks may incorporate the word "Central" (for example, European Central Bank, Central Bank of Ireland, Central Bank of Brazil). In some countries, particularly in formerly Communist ones, the term national bank may be used to indicate both the monetary authority and the leading banking entity, such as the Soviet Union's Gosbank (state bank). In rare cases, central banks are styled "state" banks such as the State Bank of Pakistan and State Bank of Vietnam.

Many countries have state-owned banks or other quasi-government entities that have entirely separate functions, such as financing imports and exports. 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. Some state-owned commercial banks have names suggestive of central banks, even if they are not: examples are the Bank of India and Central Bank of India.

The chief executive of a central bank is usually known as the Governor, President or Chair.

21st century

After the Financial crisis of 2007–2008 central banks led change, but as of 2015 their ability to boost economic growth has stalled. Central banks debate whether they should experiment with new measures like negative interest rates or direct financing of government, "lean even more on politicians to do more". Andy Haldane from the Bank of England said "central bankers may need to accept that their good old days – of adjusting interest rates to boost employment or contain inflation – may be gone for good". The European Central Bank and The Bank of Japan whose economies are in or close to deflation, continue quantitative easing buying securities to encourage more lending.[33]

Other Languages
Alemannisch: Notenbank
العربية: بنك مركزي
asturianu: Bancu central
azərbaycanca: Mərkəzi Bank
Bân-lâm-gú: Tiong-iong gîn-hâng
български: Централна банка
bosanski: Centralna banka
català: Banc central
Cymraeg: Banc canolog
Deutsch: Zentralbank
eesti: Keskpank
español: Banco central
Esperanto: Centra banko
euskara: Banku zentral
français: Banque centrale
Gaeilge: Banc ceannais
한국어: 중앙은행
Bahasa Indonesia: Bank sentral
íslenska: Seðlabanki
italiano: Banca centrale
עברית: בנק מרכזי
қазақша: Орталық банк
latviešu: Centrālā banka
Lëtzebuergesch: Zentralbank
lietuvių: Centrinis bankas
македонски: Централна банка
Bahasa Melayu: Bank pusat
Nederlands: Centrale bank
日本語: 中央銀行
norsk nynorsk: Sentralbank
oʻzbekcha/ўзбекча: Markaziy bank
ភាសាខ្មែរ: ធនាគារកណ្ដាល
português: Banco central
саха тыла: Киин баан
Simple English: Central bank
slovenčina: Centrálna banka
slovenščina: Centralna banka
српски / srpski: Централна банка
srpskohrvatski / српскохрватски: Centralna banka
svenska: Centralbank
татарча/tatarça: Üzäk bank
Türkçe: Merkez bankası
українська: Центральний банк
Tiếng Việt: Ngân hàng trung ương
文言: 中央銀行
粵語: 中央銀行
中文: 中央银行