A Central Bank is defined as the financial institution given the responsibility of the production

and distribution of money and credit for a nation. In modern economies, the central bank is
usually responsible for the formulation of monetary policy and the regulation of member banks.
Timeline of Central Bank: to know the history of the central bank we have to go back at
least in the seventeenth century and the timeline of the central bank follows:
Swedish Riksbank: the first institution recognized as a Central Bank was established in 1668. It
was charged with the responsibility of lending funds to the government and acting as a clearing
house for commerce
Bank of England: the most famous central bank of the era, the Bank of England was founded in
1694 to purchase government debt.
Banque De France: was established in 1800 to stabilize the currency after the hyperinflation
during the French Revolution
Federal Reserve: severe financial crisis that hit the United States in 1907 led to the creation of
the country's central bank, the Federal Reserve, in 1913. It was mandated to provide a common
currency which would respond to the changing seasonal, cyclical and secular needs of the
economy and to serve as a lender of the last resort.

In Bangladesh Bank Order No. 127 of 1972 we can find the the multiple responsibilties that the
central bank of Bangaldesh carries out. However the functions might contradict each other. The
functions and the challenges that the central bank faces while implementation of its functions,
Bangladesh perspective taken into consideration are as follows:

1. Conduct of Monetary Policy So as To Control Money Supply and Influence Inflation

and Interest Rates:
We know money supply and the interest rates have a negative relationship and monetary policy
should exert control over both the money stock and the interest rate simultaneously to affect the
economy. Bangladesh Bank in its Monetary Policy Statements have stated that recognition is
usually given to both broad money and interest rates with a view to ensure sustainable growth
and moderate inflation. This is consistent with Paul Samuelson's quotation from his article of
1967, where he concluded that central bank should watch both of the things together.
A large portion of the broad money stock consists of the net foreign asset (determined by
exports, remittances and inflow of foreign capital) and credit to the public sector (government
borrowing and borrowing by other public sector entities some of which receive government
guarantee). And both of these money stock remains outside the control of the Bangladesh bank,
hence creating a major challenge for the monetary policy in Bangladesh. Another problem is that
up until Bangladesh maintained a large excess liquidity. So, it was a futile effort to change
money supply by bringing changes in the cash reserve requirement/statutory liquidity
requirement or treasury bond operations.
The normal transmission channel of monetary policy is that an increase in money supply would
cause a reduction in interest rate, this would lead to increase in investment and thereby higher
aggregate demand and higher GDP and vice versa. And in the context of Bangladesh growing
GDP is one of the primary objectives thus increasing money supply and thereby reducing the
interest rate is the target of Bangladesh bank. But the problem is that the financial system of
Bangladesh does not operate under the principles of competition. The banks, particularly the
private ones, collusively determine the lending rate with little regard for money supply
conditions, causing the opposite of the normal transmission channel i.e., higher growth of broad
money relative to the preceding year was accompanied by higher interest or a lower growth of
money supply was accompanied by lower interest. And for an import import-dependent economy
like Bangladesh, domestic prices are largely determined by international prices. Hence,
effectiveness of monetary policy in containing inflation is bound to be limited.

2. Prudential Regulation
The central bank is responsible for the supervision and regulation of the country’s financial
market to ensure stability and soundness of the banking system of the economy. Asymmetric
information and moral hazard are what influences the making of the regulation and supervision
necessary.
There exists asymmetric information between the bank management and the depositors. The
depositors lack exact information about the banks’ true state and end up depositing their money
without scrutinising the solvency of the bank, because they know that if the bank gets bankrupted
the government will bail it out and they will recoup their deposits. So, this moral hazard makes
the banking system inefficient since the funds are not being channelled to the productive banks.
Thus, central bank must supervise and regulate the banks’ solvency so that they don’t default
their depositors.
Again, there exists asymmetric information between the bank and the borrowers. Banks lacks the
full information of the potential risks and returns of the loan proposals. It is not easy to bridge
this asymmetry even though banks may diligently screen the loan proposals. Hence banks may
end up financing high-risk proposals some of which may fail. Banks’ perception is that, in the
event of any trouble, the government will bail them out. Such a perception may undermine due
diligence by banks and exert strongly negative impact on the soundness of the financial system
and real sectors of the economy. So, this moral hazard again makes the banking system
inefficient since the funds are not being channelled to the productive borrowers. Thus, central
bank must supervise and regulate the investments of the financial institutions.

3. Lender of Last Resort

Most central banks provide some form of credit facility, which can be used to provide liquidity
and facilitate payments settlement for banks in distress. Central bank's last resort lending will
generally take the form of liquidity injections directed to a particular bank or set of banks and
may need to be sterilised by reducing liquidity elsewhere, for example, through open market
operations or other instruments. The intent of central bank LOLR facilities is not to provide
resources to insolvent institutions, but to provide temporary liquidity to sound institutions,
typically at a penalty rate. In practice, however, both central banks and supervisors often have
difficulty distinguishing illiquid but solvent banks from insolvent ones. This is even more
difficult when most banks or the entire system is in distress.

4. Use of directed credit to cater to the financial needs of socially desirable sectors which
do not benefit from the usual channels of transmission of monetary policy
Many developing countries have followed a policy of directed credit to selected sectors, often at
subsidised rates, with a view to accomplishing certain development objectives which included
industrialisation, employment creation, increase of food production, export promotion etc.
Directed credit can, therefore, be viewed as an instrument of non-price rationing or non-market
allocation. The justification is that private sector may be unwilling to undertake investment in
some desirable activities because of market failures. Governments may prefer directed credit at
subsidised rates as an alternative to providing direct subsidies out of the budget for political
reasons. They also prefer directed credit over budgetary subsidies because it is presumed that
banks which provide such loans are likely to exercise effective control over the utilisation of
funds as they have a direct stake in the success of the recipient enterprises. The failure of the
concerned projects would jeopardise the recovery of loans and vice versa.
In Bangladesh it has been a common practice to influence allocation of credit. In most cases,
efforts have been made to enhance the flow of credit to certain activities like- agricultural sector,
schemes for solar energy or Refinancing Scheme for Small Entrepreneur. Bangladesh Bank
should continuously monitor compliance with directed credit requirements and evaluate impact
on cherished objectives.

5. Implementing Exchange Rate Policy

It’s the duty of the central bank to intervene the foreign exchange market from time to time in
order to monitor and control the exchange rate of the economy. Bangladesh has been no
exception to this widespread practice. In reality the issue relates to the need for depreciation
often demanded by exporters.
The Bangladesh Bank intervenes the exchange rate market to depreciate the country’s currency
so that the export orientated garment sector of the economy can increase the volume of their
export sales due to reduced domestic consumption. The combined result is to increase the
volume of exports. The exporters earn greater revenue, proportionate to the increase in the
volume of exports and the magnitude of depreciation. However, there are undesirable
consequences of depreciation- depreciation increases the domestic price of most goods -
imported machinery, raw materials, intermediate goods and final consumption goods (including
those which are exported and domestically produced import-competing products). As a result,
depreciation may stoke inflation. Depreciation would also cause an adverse impact on
Government finances. The subsidy requirements for food, fuel and fertiliser imported mostly by
the Government would go up if the present price level is to be maintained. Furthermore, taka cost
of external debt service will also increase.