Difference Between Central Bank and Commercial Bank

Edited by Diffzy | Updated on: August 18, 2023

       

Difference Between Central Bank and Commercial Bank

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Introduction

Every country requires banks in order to operate the monetary functions of its economy. Banks work as financial institutions which bridge the gap between the government and the common people or firms. These financial institutions help in managing the overall economic development of the country and offer various services to individuals and firms starting from borrowing/lending or depositing the money, granting loans, etc. These Banks, which are in direct contact with the individuals and the firms are operated by one single bank or the apex bank/financial institution of the country which is known as the Central Bank. It is generally one in number in each country.

Central Bank vs Commercial Bank

Central bank is the apex financial institution that is responsible for the monetary policies of the country whereas Commercial banks generally perform banking and other financial-related functions. The Central bank is the regulatory authority that manages the commercial banks and the commercial banks work with individuals and firms under regulations made by the Central bank. In India, the Reserve Bank of India (RBI) acts as the Central bank of the nation.

Difference Between Central Bank and Commercial Bank in Tabular Form

Parameters of ComparisonCentral BankCommercial Bank
DefinitionCentral Bank offers monetary policies and is the top financial institution of any nationCommercial Banks offer banking and other financial services to their customers who are individuals and firms
ExampleIn India, RBI or the Central Bank prints the notes(paper currency) and regulates various bank rates, interest rates, etc.In India, commercial banks like SBI(State Bank of India) or Canara Bank, etc., facilitate deposits, loan facilities, etc, to their customers
Profit earningCentral Bank works in the interest of the public and not  with the motive of earning profitCommercial Banks work with the motive of earning profit out of deposits made by the public
OwnershipCentral Bank has public ownership/government ownershipCommercial Banks can either have public or private ownership
Power to ControlCentral Bank has the control over activities of commercial banksCommercial banks follow the regulations and interest rates set by the Central Bank
AuthorityCentral Bank has the authority to create policies and issue currencies in an economyCommercial Banks do not have any such control to create policies
Presence in terms of numbersCentral Bank is one in number in a nationThere are multiple Commercial Banks in an economy
Deals withCentral Bank deals with the government and other various banksCommercial Banks deal with the general public and firms

What is a Central Bank?

The Central Bank is one financial institution with monetary control over a country's economy. It is responsible to frame various monetary policies, issuing currencies, regulating bank & interest rates, currency supply, etc. The main objective of the Central Bank is to regulate monetary policies by stabilizing the money supply and ultimately achieving economic growth. Any individual or firm willing to open an account can open it in a commercial bank but not in the Central Bank since it does not directly deal with the public. The Central Bank in India is under the control of the Ministry of Finance. The Central Bank acts as a bank to all other Commercial banks and performs many functions.

Functions Performed by the Central Bank

  1. Bank of Issue- Central Bank only has the power to manufacture notes in an economy because if many banks in a country get this control, then it will result in an unorganized economy.
  2. Bank to the government- Central bank acts as a bank to the government as it can provide funds to the government in case of emergencies and it accepts deposits on behalf of the government. The central bank can also pay or receive payments for the government and can provide short-term or long-term loans to the government in dull phases of the economy. In short, we can say that on the one hand, the commercial bank is in direct contact with individuals and firms, and on the other hand, the Central Bank connects directly with the government and can act as a bank to the Government of the country.
  3. Lender of last resort- There can be times when even commercial banks can run out of funds and at that time, they will need help from the Central Bank. So, commercial banks can borrow funds from the central bank at a rate which is known as the repo rate, and the Central Bank can lend money to the commercial banks for some specific period. Therefore, the Central Bank can be called the Lender of Last Resort. It also provides loans against security or treasury bills where it helps in protecting the financial structure of an economy. The central bank can regulate the repo rate as for maintaining the demand and supply of money in the market. If the central bank wants to increase the supply of money in the market it will lower the repo rate so that the commercial banks can buy the funds from Central banks in an easy way but if the Central Bank wants to lower the supply of money in the market then it will increase the repo rate so that the commercial banks will try not to buy or borrow funds from the Central Bank as repo rate is directly related to the interest rate that will be levied by the commercial banks and it will directly affect the decisions of the individuals and the firm's borrowing funds from commercial banks
  4. Custodian of Cash Reserves- the commercial banks keep a part of their funds with the central bank in the form of cash reserves so that the central bank can offer it in times when the commercial banks need it and the rate at which Commercial Banks keep the deposits with the central bank is known as reverse repo rate. The central bank regulates these rates as per the requirement of currency in the economy. If the central bank wants to create a demand in the economy so it will lower the reverse repo rate so that the commercial banks keep just a minimum amount of funds with the Central Bank and lend to the public, while on the other hand if Central Bank wants to hold the currency, then it will increase the reverse repo rate so that the commercial banks keep the money with the central bank and can earn from there.
  5. Custodian of International Currency- Central Bank works as a custodian of international currency since it is required to maintain a minimum amount of foreign reserves with it so that they can be utilized in case of emergency or sudden requirements and it can also be used to overcome any deficit of Balance of payments.
  6. Controller of credit- By the use of Open Market Operations (OMOs)_ the central bank can control the way credit creation is done by commercial banks by bringing about a change in cash reserve ratio or CRR because a lot of credit creation in the economy can lead to inflation. The cash reserve ratio refers to the minimum percentage of cash reserves that a commercial bank is required to keep with the central bank.
  7. Clearing-house function- One of the important functions of the Central Bank is the clearing house function. Since the Central Bank has control over commercial banks, many interbank payments can be cleared by the Central Bank as it can help in the settlement of mutual payments or receipts of commercial banks.
  8. Protection of Depositors' Interest- To protect the interest of the depositors and to create a sense of confidence in the minds of depositors for commercial banks, the Central Bank keeps a check on the working of commercial banks regularly.

Examples of Central Banks Across the Globe

  1. Reserve Bank of India (RBI)
  2. The U.S. Federal Reserve
  3. The European Central Bank
  4. The Bank of England
  5. The Bank of Japan
  6. The Swiss National Bank
  7. The Bank of Canada
  8. The Reserve Bank of Australia
  9. The Reserve Bank of New Zealand
  10. People's Bank of China

What is Commercial Bank?

A commercial bank is a financial institution that receives deposits from the public and grants them as loans to them along with earning a profit on the same. Individuals or firms make deposits when they have excess money or for investment by way of FD (Fixed Deposit) or RD (Recurring Deposit) and they require loans for the purchase of any asset, like purchasing a house or a car, and for other investment purposes.

Commercial Banks accept deposits from the public and then grant loans with the same deposits to other individuals or firms. In this process, they earn a certain amount of profit and this process is known as credit creation.

Functions of Commercial Banks

The functions of commercial banks can be divided into two categories:

  1. Primary functions
  2. Secondary functions

Primary Functions

  • Accepting Deposits-  Commercial banks accept deposits from the public in the form of savings accounts, current accounts, or fixed deposits.
  • Granting Loans- Banks keep a certain amount of deposits with them and lend the excess of it in the form of loans, short-term or long-term, overdraft, or cash credit.

Secondary Functions

  • Overdraft Facility- Banks give this facility to its customer when they run out of balance in their accounts
  • Locker facility- Banks offer this facility to its customers so that they can keep their valuable documents and charges a fee for the same
  • Discounting the bills of exchange- Banks can even discount a bill of exchange at an earlier date if the owner of the bill requires the funds immediately.

Public Bank- These are the banks owned by the government or the giver has a significant stake in these banks

Private Bank- These are the banks that are privately held by individuals

Foreign Bank- These are the banks of a nation having its branches in other countries

Currently, there are 12 public sector banks, 22 private sector banks, and 46 foreign banks in India.

Examples of Commercial Banks in India

Public Banks

  1. State Bank of India (SBI)
  2. Punjab National Bank (PNB)
  3. Canada Bank
  4. Indian Overseas Bank

Private Banks

  1. Industrial Credit and Investment Corporation of India (ICICI Bank)
  2. Housing Development Finance Corporation (HDFC Bank)
  3. Axis Bank
  4. Indusland Bank

Foreign Banks

  1. Citi bank
  2. Bank of America
  3. Doha bank
  4. DBS bank

Main Differences Between Central Bank and Commercial Bank In Points

  • The central bank is one apex financial institution whereas there are multiple commercial banks in a nation
  • Central bank is responsible for monetary policies whereas Commercial banks are responsible for banking and other financial services
  • Central bank deals with government and other banks whereas Commercial Banks deals with public
  • Central bank print currency notes but Commercial bank does not have any such power
  • Central bank runs with the motive of regulating the economy with one single higher authority for money control whereas Commercial banks run with the motive of earning profit out of deposits made by public
  • The Central bank has public ownership whereas a commercial bank can either have public or private ownership.
  • Central Bank acts as a Banker to several other commercial banks and has the highest authority in any country

Conclusion

Central banks and commercial banks are crucial financial institutions of a country as they help in maintaining overall economic growth and financial stability. While there are many commercial banks in an economy, there is one single central bank that regulates the government and all other several banks. Since commercial banks can directly contact individuals and firms, they make a profit out of deposits made by the public. The central bank regularly keeps an eye on commercial banks so that the economy runs smoothly and depositors continue to show confidence in commercial banks of the country. The Central bank is owned by the public sector while commercial banks can be held by either the public or private sector. Both the Central bank and commercial banks together form a backbone for the economic well-being of a county and the absence of any one of them can lead to an imbalance in the economy, as the Central bank is the one that issues currency and maintains money supply and commercial banks are the ones that deal with the public for lending or borrowing of funds with the bank. Therefore both of them play a unique role in an economy for its smooth functioning.

References

  • https://www.ecb.europa.eu/ecb/educational/explainers/tell-me/html/what-is-a-central-bank.en.html
  • https://www.britannica.com/money/topic/central-bank
  • https://www.geeksforgeeks.org/difference-between-commercial-bank-and-central-bank/amp/
  • https://en.m.wikipedia.org/wiki/Commercial_bank
  • https://testbook.com/amp/key-differences/difference-between-central-bank-and-commercial-banks-in-india

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