Przemyslaw Jaroslaw Galusiakowski 1 Compare and contrast the work of a Commercial Bank (such as NatWest or Barclays) with that

of a Central Bank such as the Bank of England

There are many differences and similarities between a central bank and a commercial bank. In this essay I will try to compare and contrast both types of institutions. Examples of a central bank are the Bank of England, which is the model for this kind of institutions in many countries, the European Central Bank or the National Bank of Poland. Examples of a commercial bank are Barclays, HSBC or BNP Paribas. A central bank (sometimes called monetary authority or reserve bank) is the apex monetary institution that has been empowered to wield a control over the entire banking system of the country where it functions whereas commercial banks are only constituent units of this system. As opposed to a commercial bank, a central bank has a monopoly on increasing the country's monetary base and often prints the national currency, which usually serves as the legal tender in a given country. Another important contrast is that a central bank is not profit-oriented. The main goal of this institution is to fulfill the objectives of the government's economic policy and maximise the social welfare through some monetary measures. Commercial banks, on the other hand, operate with a profit motive, which is their primary aim. The problem of ownership is another distinctive characteristic of these types of institutions. In case of commercial banks, the owners are generally private firms or units, while central banks are organs of the government. The Bank of England, for example, was privately owned prior to 1946 when it was nationalised. Currently, it is a corporate body with its stock held by the Treasury Solicitor on behalf of HM Treasury (Bank of England, 2011). It is, however, important to mention that many of the central banks operating today, were private at some point in history. They usually had some agreement with government which enabled them to have a monopoly on the currency issuance or to operate as the government's bank. The Bank of England, for example, was established by Charles Montagu, 1st Earl of Halifax, in 1694, who offered a loan of 1.2 million to the government in exchange for the longterm banking privileges (the right of notes issuance among many others) (Roseveare, 1991). A central bank has usually been granted a right to issue notes in contrast to commercial banks, which do not have such right. Once again, I will provide the example of the Bank of England. It is the sole

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issuer of banknotes in England and Wales (in Northern Ireland and Scotland the notes are issued by retail banks). Their amount depends largely on the demand for notes from the general public (Sloman, 2011). In some nations, the government is responsible for the issuance of the currency notes of smaller denominations and coins and they act as the ultimate legal tender, while the central bank issues the larger currency denominators. Commercial banks, as I mentioned, generally do not have a right to issue currency, but instead they issue cards (credit, debit, etc.) which is their own way to influence the consumer spending. A central bank also serves as the bankers' bank. First of all, the commercial banks are required by law to keep an account and a certain amount of their reserves in central bank. Secondly, at the time of emergency, a central bank helps commercial banking system. Moreover, it refinances commercial banks' debts at the prevailing discount rates. Finally, a central bank serves as the clearing house for the commercial banks. By contrast, commercial banks do not perform any of the abovementioned functions and their interest is directed towards the public. Nevertheless, sometimes central banks can turn for help to the Bank for International Settlements (BIS) which acts as the central bankers' bank and is not accountable to any government. Central banks do not compete with commercial banks. Instead, they usually help them by acting as the lenders of last resort. Their aim it to protect depositors, avert the society from panic withdrawal and to avoid disruption in productive credit to the economy which can result from the bankruptcy of one or more financial institutions. Commercial banks generally borrow money from the lender of last resort during the crises as it can indicate that the institution has taken on too much risk or that it is experiencing some serious financial difficulties. In major economies this function is performed usually by central banks such as the Bank of England in the UK, the US Federal Reserve in the USA, the Swiss National Bank in Switzerland, the Central Bank of Russia in Russia or the Bank of Japan in Japan. Nevertheless, it is worth mentioning that sometimes some commercial banks also performed this function on several occasions, e.g. JPMorgan Chase or HSBC. (Forexpedia, n.d.) Commercial banks act as bankers to the general public, while central banks act as bankers to the governments. In these terms, central banks perform many important functions like managing governments' borrowing, lending, payment of accounts and income from taxation. Another important function is raising money for the government via various instruments, e.g. bonds or T-Bills. The former function is linked to the monetary management of the economy, whereby issuance or

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redemption of T-Bills impact the money supply in the economy. Central banks are also usually vested with the authority of setting various rates, which can constitute important monetary policy instruments with it. These rates include the cash reserve ratio (CRR) and the interest ratio. The CRR is the ratio of all deposits that commercial banks are mandated to keep with the central bank. The interest rate is managed by central bank by changing the discount rate at which the central bank refinances commercial banks. Central banks can also use their levers of interest rates to encourage or discourage investment and affect employment levels in the economy (Forexpedia, n.d.). Commercial banks operate quite similarly to central banks as they also make different type of loans (secured, unsecured, mortgage), perform various types of services (money transfers, investment advices, etc.) and offer deposit accounts, however, as I already mentioned, they are directed towards the firms and consumers where they reside, while central banks offer their services to their governments, commercial banks and other financial institutions (Wolf, 2011). Central banks also carry out international monetary duties. They perform an important functions in the foreign exchange markets by trying to control the money supply, inflation, and interest rates and usually have official or unofficial target rates for their currencies. They can also use their often substantial foreign exchange reserves to stabilize the market, however, the effectiveness of central bank "stabilizing speculation" is doubtful as central banks do not go bankrupt if they make large losses like other traders, and there is no convincing evidence that they do make a profit trading (Forexpedia, n.d.). Commercial banks also participate in the foreign exchange markets, but they are only the dealers in foreign exchange. Another important issue is the national (government) debt. Commercial banks do not play any role in managing the national debt, while central banks do. They float new loans, repay them due to mature and pay interest to bondholders. As most developed country governments are prohibited by law from printing money directly, that function have been relegated to their central banks, however, central banks may buy government bonds in order to finance government spending and monetize the debt. As opposed to commercial banks, central banks manage a government's monetary policy. At the most basic level, it involves establishing what form of currency the country may have, whether a fiat currency, gold-backed currency, currency board or a currency union. The main monetary policy instruments available to central banks are open market operation, bank reserve requirement, interest rate policy, re-lending and re-discount, and credit policy. Particularly important are interest rates and

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money supply. The most obvious power of most modern central banks is the influence on the market interest rates. Even though, the mechanism is different in most of the countries, the majority uses a similar one based on a central bank's ability to create as much fiat money as required. Through open market operations, a central bank directly influences the money supply in an economy. In many countries central banks exercise the control over and monitor the entire banking industry of a country. In other countries such as the UK, the banking system is supervised not only by the central bank but also by the specific government department (e.g. the UK Treasury) and the independent government agency (Financial Services Authority). Some countries such as the United States control the banking industry by a variety of different agencies which co-operate with each other in order to provide an appropriate regulation. Some types of banking regulation can be assigned to other levels of government, e.g. state or provincial. Commercial banks, thus, are sub-servant to a central bank.

REFERENCES:
Bank of England (2011). Ownership of the Bank of England. Retrieved from: http://www.bankofengland.co.uk/publications/foi/disc111220a.htm

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Carl Wolf (n.d.). Similarities of a Commercial Bank and a Central Bank. Retrieved from: http://www.ehow.com/list_6528329_similarities-commercial-bank-central-bank.html Forexpedia (n.d.). Central Banks. Retrieved from: http://www.babypips.com/forexpedia/Category:Central_Banks Roseveare, H. (1991). The Financial Revolution 16601760 (pp. 34). Longman Sloman, J. (2009). Economics (seventh ed.) (pp. 512). Harlow: Pearson Education Ltd.