- Central bank
- A central bank is the organisation responsible for conducting monetary policy and ensuring that a country's financial system operates smoothly.
- Commercial bank
- A commercial bank is a financial intermediary that takes deposits from savers and lends to borrowers, bringing the two together.
The functions of a central bank
Can you name the five functions of a central bank?
In the UK every one of these belongs to the Bank of England.
Monetary policy is the central bank's decision to raise or lower interest rates, aiming at low inflation and low unemployment.
Can you think of an example?
The Bank of England's Monetary Policy Committee sets Bank Rate to hit the inflation target that the Chancellor sets.
As banker to the banks, the central bank holds commercial banks' accounts, where they keep reserves and settle payments with each other.
Can you think of an example?
When a customer of one bank pays a customer of another, the banks settle by moving reserves between their accounts at the Bank of England.
As banker to the government, the central bank holds the government's accounts, through which the money it raises and spends passes.
Can you think of an example?
HM Treasury's National Loans Fund is an account at the Bank of England, which reports every payment into and out of it daily to the Comptroller and Auditor General.
A lender of last resort stands ready to lend to banks and other financial institutions when they cannot obtain funds from anywhere else.
Can you think of an example?
A rumour sets off a run on a sound bank. The Bank of England lends it cash against its assets, so it can pay every depositor.
Financial regulation is supervising banks so each stays safe and sound, and acting on risks to the financial system as a whole.
Can you think of an example?
The Bank's Prudential Regulation Authority checks each bank holds enough capital; its Financial Policy Committee watches for risks such as unsustainable credit growth.