The Central Bank is the apex body of the banking system. It supervises, co-ordinates and controls the operations and activities of the commercial banks. As their bank it undertakes following functions:
(A) Custodian of Cash Reserve: It is a legal tradition that all commercial banks should keep a certain portion of the demand and time deposits with the Central Bank of the country. This proportion is called cash reserve ratio. This minimum cash reserve requirement can be changed by the Central Bank. The Central Bank pays interest to the banks on cash reserve ratio balances.
The cash reserve ratio enables the Reserve Banks of India to advance funds to banks that face temporary liquidity crisis. It is also an instrument of credit control.
(B) Lender of last Resort:
The Central Bank acts as a lender of last resort to commercial banks. Whenever any commercial bank faces liquidity problems, the Central Bank provides funds to overcome crisis. 'The lender of last resort' function of central bank helps to control panic and infuses confidence among the banks as well as the public. Hence, during financial difficulties or crisis commercial banks can always depend on central bank for the required assistance.
(C) Clearing House:
The Central Bank acts as a clearing house for transfer and settlement of mutual claims of commercial banks. Since all commercial banks have their accounts with the Central Bank, the claims of banks against each other are settled by simple transfer i.e., by debit and credit entries in their accounts. Thus the inter bank indebtedness can be easily settled without using cash. This is possible as banks keep cash reserves with central bank.