Similarities and Differences Between Central Bank and Commercial Banks

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Alt: = "U.S Federal Reserve building"
Photo Source: federalreserve.gov


What is Central Bank?

A Central Bank is a government-owned bank which helps to control and supervise the entire monetary and financial system of a country. In some territories, Central Bank is also referred to as Federal Reserved Bank. Being a financial organ of the government, of carries out the major financial operations of the government. It regulates, directs, assists and coordinates the operations of other financial institutions so as to make them comply with the monetary and economic policies of the government. 


What Is a Commercial Bank?

Commercial banks are what most people think of when they hear the word "bank." They lend money, accept deposits, offer checking and savings accounts and offer a variety of other financial products. Even though the word "commercial" makes it sound like they deal only with or primarily with businesses, this is not the case. Commercial banks provide banking services to both individuals and companies or enterprises.


Similarities Between a Central Bank and a Commercial Bank

Central Bank and commercial banks have very different roles within the economy, but one needs the other to exist well and to serve the public well. Even with all of the differences between Central Bank and commercial bank responsibilities, they still share several things in common:

1. Money: Both commercial banks and central banks create money. While the Federal Reserve issues legal tender and injects it into the economy, commercial banks create money by offering loans to the public. While the commercial bank is likely to have more liabilities than assets, the reserve requirements set by the Federal Reserve ensure they keep it in check and prevent bank runs. 

2. Economy: Both Central Bank and commercial banks have a powerful influence on the economy. Both can create money or slow down economic growth with their lending patterns. The Federal Reserve influences how commercial banks do this, and commercial banks must answer to the regulations of the Federal Reserve. 

3. Deposits: Both Central Bank and commercial banks accepts deposits. While Central Bank accepts deposits from the government, commercial banks and other financial institutions, commercial banks accept deposits from the public. All the same, the aim of accepting deposits is for safekeeping of wealth.

4. Loans: Both commercial banks and central banks issue loans. While the Central Bank issues loans to commercial banks or to the federal government and states governments, commercial banks issue loans to individuals and businesses. Sometimes, Central Bank issues loans directly to individuals and businesses through its interventionist programs to drive the economic policies of the government. Whichever way, loans are given to facilitate economic development of a country. They utilize interest rates in order to generate income streams that sustain growth. 

5. Foreign Exchange: Both Central Bank and commercial banks facilitate international trade by providing and making foreign exchange transactions easier. They both can assist in international trade by issuing letters of credit to importers.

Read also: Advantages and Disadvantages of Central Bank in Modern Economy

Differences Between Central Bank and Commercial Banks

Despite the fact that commercial banks and the central bank belong to the class of financial institutions in the money market which deal in money and credits, contribute to the economic development and carry out certain similar banking functions for their customers, they differ in certain respects.

1. The Central Bank is usually a government owned bank while commercial banks are public companies (joint-stock bank) owned by individuals institutions, or in joints partnership with the government.

2. Being a government-owned enterprise, the Central Bank is responsible to the government, while the commercial banks are responsible to the shareholders who own them.

3. The Central Bank deals mainly with the government and other financial institutions, while the commercial banks deal predominantly with private customers. The government, commercial banks and other financial institutions have accounts with the Central Bank and use it as their bank, while commercial banks deal mainly with the public.

4. Central bank issues currency, while commercial banks do not.

5. Central Bank does not accept deposit from the public’s, while commercial banks accept deposits from the public and perform other functions for them.

6. The Central Bank helps to formulate government monetary policy which will help create monetary stability in the country, while the commercial banks do not formulate government policy — they only help to carry out the policies in line with Central Bank guidelines.

7. Central Bank regulates foreign exchange transactions, maintains external reserves and does external business directly, but commercial banks do not do so directly. Commercial banks intending to do external business must do so QN behalf of the Central Bank or through it.

8. Central Bank operations are not primarily based on profit motive, while the commercial banks operate in order to maximize profits. A Central Bank can undertake an operation that involves a loss, provided such is considered to be in the interest of the majority of the public. But the operations of commercial banks are based on profit move and they must make enough profits for their shareholders.

Read also: Advantages and Disadvantages of Central Bank Controlling Commercial Banks & Other Financial Institutions


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