FE: Central Bank

 1. How would central bank maintain the stability of financial system?


1. Monetary Policy: Central banks formulate and implement monetary policy to

manage the money supply, interest rates, and credit availability. They use tools

like open market operations, reserve requirements, and discount rates to

influence these factors. By maintaining price stability and controlling inflation,

central banks help ensure the overall stability of the financial system.

Example: If the central bank observes that inflation is rising above the target level, it may

increase interest rates to reduce borrowing and spending, thereby slowing down the

economy and curbing inflationary pressures.


2. Lender of Last Resort: Central banks act as a lender of last resort to provide

liquidity support to commercial banks and financial institutions during times of

financial distress or liquidity shortages. By providing emergency funding, central

banks prevent widespread panic, bank runs, and potential systemic collapses.

Example: During the global financial crisis in 2008, central banks around the world,

including the U.S. Federal Reserve, provided liquidity to financial institutions to prevent

the collapse of major banks and stabilize the financial system.


3. Financial Regulation and Supervision: Central banks establish and enforce

regulations and supervise financial institutions to ensure their soundness and

stability. They set prudential requirements, conduct regular audits, and oversee

compliance with rules and standards. This helps mitigate risks, enhance

transparency, and protect the financial system from potential disruptions.

Example: The Bank of England, along with other regulatory bodies, implements strict

regulations on banks, such as capital adequacy requirements, stress testing, and risk

management standards, to maintain the stability of the UK's financial system.


4. Crisis Management and Resolution: Central banks develop frameworks and

procedures to manage financial crises effectively. They work closely with other

regulatory agencies and government bodies to identify and address systemic

risks, resolve troubled institutions, and minimize the impact on the overall

financial system.


Example: The European Central Bank (ECB) played a critical role in managing the

Eurozone sovereign debt crisis. It provided emergency liquidity assistance to struggling

banks, conducted stress tests, and participated in bailout programs to stabilize the

financial system in the affected countries.

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