Central & Commercial Banks (Cambridge (CIE) IGCSE Economics): Revision Note

The role and importance of central banks

• A central bank is the main financial institution of a country, responsible for managing the nation’s currency, money supply and interest rates

• The Central Bank plays a vital role in maintaining stability in the financial system

  • The policy tools at their disposal help to meet government economic objectives and create economic growth

What do central banks do?

1. Implement monetary policy

• Monetary policy is the adjustment of interest rates and the money supply so as to influence total demand and meet the inflation target

2. Banker for 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

3. Banker to the commercial 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

4. Regulation of the banking industry

• Regulation is when the government sets rules or laws to control the way consumers and producers behave in a market

• The high level of asymmetric information in financial markets requires that commercial banks are regulated in order to protect consumers

The role and importance of commercial banks

• Commercial banks are financial institutions that accept deposits from individuals and businesses, and provide loans and other financial services for profit

Roles of commercial banks

• Accepting deposits

  • Provide safe storage for customers’ money

  • Offer different types of accounts (current, savings, fixed deposit) with varying interest rates

• Lending to customers

  • Provide loans, overdrafts, and mortgages to individuals and businesses.

  • Generate profit mainly through interest charged on loans

• Facilitating payments

  • Offer payment services such as debit/credit cards, cheque clearing, and online banking

  • Enable domestic and international transfers (e.g. SWIFT payments)

• Providing financial advice

  • Advise customers on investments, savings and business finance

• Foreign exchange services

  • Exchange currencies for trade, travel or investment

Importance of commercial banks

• Encourage saving

  • They provide a secure place for individuals and firms to save, helping to mobilise funds for investment

• Support business growth

  • Offer credit facilities for expansion, working capital and start‑up capital.

• Economic stability

  • Help circulate money in the economy by channelling savings into productive investments

• Facilitate trade

  • Provide trade finance, letters of credit, and foreign currency for importers and exporters

• Convenience

  • Offer easy access to financial services through branches, ATMs and online banking