Central & Commercial Banks (Cambridge (CIE) O Level Economics)
Revision Note
Written by: Steve Vorster
Reviewed by: Jenna Quinn
The Functions of Central Banks
Central Banks play a vital role in maintaining stability in the financial system. Additionally, the policy tools at their disposal help to meet Government economic objectives and create economic growth
Implementation of monetary policy: This is more fully explained in Sub-topic 4.4.1
Banker to the government: The Government sets the annual budget but it is the Central Bank that manages the tax receipts and payments. In 2022 there were 5.7 million public sector workers in the UK who had to be paid by the Central Bank each month
Banker to the banks – lender of last resort: Commercial banks are able to borrow from the Central Bank when they run into short-term liquidity issues. Without this help, they might go bankrupt leading to instability in the financial system - and a potential loss of savings for many households
Regulation of the banking industry: the high level of asymmetric information in financial markets requires that commercial banks are regulated in order to protect consumers
The Functions of Commercial Banks
Financial markets are any place or system that provides buyers and sellers the means to exchange goods/services and trade financial instruments
Financial instruments include loans, bonds, equities, and international currencies
Commercial Banks play a central role in financial markets
They facilitate saving: storing money for future use is essential for households and firms. It also provides a pool of money that financial institutions can lend i.e. one person's savings is another person's borrowing
They lend to businesses and individuals: access to credit is a key requirement for economic growth and development. Being able to borrow money speeds up consumption by households and investment by firms. It also allows households or firms to purchase assets and pay them off over an extended period of time e.g. mortgages on home purchases
They facilitate the exchange of goods and services: each purchase of goods/services requires the movement of money between at least two parties. Commercial Banks provide multiple ways for this exchange to happen including phone apps (e.g. Google Pay), debit cards, credit cards and bank transfers
They provide forward markets in currencies and commodities: forward markets are also called futures markets. They provide some price stability in commodity markets and enable investors to make a profit by speculating on future prices
They provide a market for equities: equities are shares in public companies that are listed on stock exchanges around the world. Commercial Banks facilitate both long term investment and speculation by providing platforms which connect buyers and sellers
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