Definition of Central Bank: History, Duties, Authorities, and Their Roles

Definition of Central Bank – In the real sense, a central bank is an institution or a financial institution that is responsible for monetary policy and creates a stable level of economic activity in a country.

The central bank is an institution that is already owned by private parties in a country’s government, has responsibility for currency stability, maintaining inflation rates, banking sector stability, and the entire financial system in a country.

The role of the central bank in Indonesia itself is temporarily assigned to Bank Indonesia. Many sources quoted, while the task of the Central Bank or in Indonesia itself, namely in a nutshell, Bank Indonesia is to make and implement Monetary Policy, to control the amount of money that flows in society so that prices for goods and services are controlled by the public.

Then in managing and maintaining the smooth running of a payment system, the regulated payment system becomes a cash and non-cash payment system. The central bank is responsible for making agreements, creating rules, standards and according to procedures that have been used in the circulation of money in society.


Definition of Central Bank

The central bank itself, in general, has the meaning of an agency that has many responsibilities for the monetary policy of a region of the country. The central bank has a role to maintain price stability and the value of the currency that has been in force in the country, which is widely known as inflation.

The central bank is obliged to keep the inflation rate under control and always at the lowest possible value or at an optimal position for the economy, by controlling the balance in the amount of goods and money. If there is too much money in circulation, the central bank has the right to use the authority it has.

In Indonesia itself, the function of a central bank is carried out by Bank Indonesia. Bank Indonesia is an independent state institution, free from the affairs of the Government or other parties, except for matters that are expressly regulated by law.

The function of the central bank in Indonesia is carried out by Bank Indonesia. The role and duties of Bank Indonesia as a central bank have undergone a fairly long evolution from initially being a circulation bank, then becoming an agent in the development of the government, and finally in 1999 has become an independent institution with the sole objective of achieving Rupiah stability.


History of the Central Bank

In a country, the level of economic stability depends very much on the value of the prevailing currency. In an effort to maintain the stability of the currency, an institution known as the central bank will be born. Recently, the role of the central bank in Indonesia itself has been handed over to Bank Indonesia or known as BI. However, it turns out that banks that already have a role as a central bank in Indonesia are not only BI.

In its journey, three banks have been recorded as central banks in this country, namely the National Bank of Indonesia (BNI), De Javasche Bank, and BI. All three have a very important role to play in maintaining the level of currency stability in the colonial era, independence until now.


De Javasche Bank: The First Central Bank in Indonesia

De Javasche Bank is the first central bank in Indonesia. This institution was built in 1929 during the reign of the Dutch East Indies led by King Willem 1. The location is right in Jakarta. De Javasche Bank made a major expansion by building branches in Sumatra, Sulawesi, Semarang, Surabaya, Kalimantan, and even in New York.

Its function was to try to print and distribute banknotes in the Dutch East Indies colony. The currency distributed at that time was the Dutch guilder. Banks that had been established with PT legal entities and at that time were called Naamloze Vennootschap, had a very important role to play in maintaining currency circulation. So even in international trade activities at that time was already high.


You can learn about K From De Javasche Bank to Bank Indonesia, Fragments of the History of Central Banks in Indonesia
by Erwien Kusuma

BNI 46: Central Bank Issuing Republic of Indonesia Oeang (ORI)

Many ordinary people claim that Bank Indonesia is the central bank owned by Indonesia after the Indonesian independence period was initiated. This assumption is wrong. If we look at the fact that BI itself was only established in 1953. At the beginning of Indonesia’s independence, the banking institution that had an important role to play in maintaining currency stability was the National Bank of Indonesia 46 or called BNI 46.

The establishment of BNI 46 as Indonesia’s central bank was based on Government Regulation in Lieu of Law Number 2 of 1946 which was made on July 5, 1946. ORI which is known as the first currency that has been issued by Indonesia.

The printing process as well as the basis for the ORI run by BNI 46 started on October 30, 1946. With the existence of the ORI, money issued by the Japanese and De Javasche Bank could no longer be valid. ORI is printed in the form of banknotes that have been signed directly by the Minister of Finance.

However, BNI’s role as the central bank at that time did not last long. The main reason is that BNI 46 has limited assets. At that time it was written that ORI circulation could not be carried out optimally and also could not be spread to all regions of Indonesia. Thus, the role of the central bank in Indonesia was transferred back to De Javasche Bank in 1949.


Nationalization of De Javasche Bank and BI Chosen as the Central Bank

In December 1951, the Government of Indonesia had adopted a policy to nationalize De Javasche Bank which was later marked by Law Number 24 of 1951 which was related to the nationalization of De Javasche Bank NV. In addition, in early July 1953, the Government of Indonesia had established Bank Indonesia and made it Indonesia’s central bank.

On this trip, BI has the same duties and roles as De Javasche Bank, namely serving as a banking institution, monetary management, and managing the payment system in Indonesia.

Furthermore, the duties and functions of BI began to decrease in 1968. This was marked by the existence of the Central Bank Law in 1968 which stated that BI would no longer carry out its role as a commercial bank, but would be tasked with being a development agent in an effort to improve people’s welfare.

However, in 1999 BI regained its role as a central bank with the issuance of Law Number 23 of 1999. With this Law, BI’s role in protecting and maintaining the stability of the rupiah value was again grasped. Then, the role of BI will increase in the aim of strengthening the Indonesian government with the creation of an amendment in 2004.

Many of these roles have been held by Bank Indonesia until now. In carrying out its role, BI in short has three main tasks, setting and implementing monetary policy, maintaining the smooth running of the payment system, and also maintaining the level of stability of the financial system in Indonesia.


Central Bank Duties

As previously mentioned, Bank Indonesia itself has its own duties and responsibilities that must be carried out properly, setting and implementing monetary policy, maintaining the smooth running of a payment system, and maintaining the level of stability of the financial system in Indonesia. Based on the understanding of the central bank, below is a complete explanation of the duties of the central bank:

1. Establish and Implement Monetary Policy

The stipulation of monetary obligations must be carried out, to maintain the circulation of the amount of currency that exists in the community, then all prices of goods and services can be maintained and controlled.

The monetary policy needs to be implemented to support national economic growth. thus, the BI must cooperate with the government in which all policies that have been set can work in accordance with fiscal policies and several other economic policies.


2. Regulate and Maintain the Smooth Payment System

The meaning of a payment system is a cash and non-cash payment system. Bank Indonesia has a full role when issuing rules, standards, agreements and procedures to be used in regulating the circulation of money.


3. Regulate and Supervise Banking

BI needs to carry out macroprudential supervision which is useful for maintaining the stability of a financial system that applies in Indonesia. This macroprudential policy is a policy that has been prepared to be able to provide limits to the risks and costs of a systemic crisis, so that it can maintain the balance of a financial system in Indonesia.


You can learn about K From De Javasche Bank to Bank Indonesia, Fragments of the History of Central Banks in Indonesia
by Erwien Kusuma


Central Bank Authority

BI, which acts as the central bank in Indonesia, has special powers regulated by the Law of the Republic of Indonesia, namely:

1. Authority to Make Monetary Policy

Bank Indonesia needs to determine and determine the discount rate, needs to make financing and credit policies. Bank Indonesia must also be able to set and determine monetary targets by determining the inflation rate that occurs in Indonesia each year.

BI also has a very important authority in monetary control by not limiting open market activities.

2. Authority to Regulate Payment System

Bank Indonesia has three basic authorities. First, BI has the authority to determine and determine the use of payment instruments. Second, making and giving approval for permits to operate a payment system. Finally, to oversee the implementation of the payment system.

3. Authority to Regulate and Supervise Banking

Then, Bank Indonesia as the central bank certainly has four main authorities. First, to have the authority to make also to establish a policy related to the implementation of banking that has been in effect in Indonesia. Second, the authority to impose sanctions on parties who have violated the policy has been established in accordance with the provisions of the law.

Third, has the authority to grant or revoke licenses in institutions and in bank business activities. Finally, BI is also authorized to supervise various conventional bank activities, in the banking system or individually.


The role of Bank Indonesia as the central bank

The question is, what is the role of Bank Indonesia in maintaining financial system stability? As a central bank, Bank Indonesia has five main roles to maintain stability in the financial system.

The five roles which cover policies and instruments to maintain stability in a financial system are:

First, Bank Indonesia has a duty to maintain monetary stability, among others through an interest rate instrument in open market operations. Bank Indonesia itself is required to be able to set monetary policy in a balanced and appropriate manner. This recalls the disruption to monetary stability having a direct impact on various aspects of the economy.

For monetary policy itself, the application of interest rates that are too tight will kill a lot of economic activity, and vice versa. Therefore, in order to create monetary stability, BI has implemented a policy known as the inflation targeting framework.

The second role, Bank Indonesia itself has an important or vital role in creating sound financial institution performance, especially in banking. The creation of a performance banking institution like that is carried out with supervisory and regulatory mechanisms. As in other countries, the banking sector has a dominant part in a financial system. Thus, failure in this sector can lead to financial instability and disrupt the economy.

To be able to prevent the occurrence of such failures, an effective supervisory system and banking policies must be upheld. Apart from that, market discipline through supervisory powers as well as policy makers and law enforcement must continue. The evidence shows that in countries that undergo a market discipline, which has a strong concept of stability in the financial system.

Meanwhile, law enforcement efforts are interpreted to be able to protect banks and stakeholders while at the same time encouraging confidence in the financial system. To be able to create stability in a sustainable banking sector, BI has prepared an Indonesian Banking Architecture and a Basel II implementation plan.

Third, Bank Indonesia already has an authority to regulate and maintain the smooth operation of the payment system. If a failure to settle event occurs at one of the participants in the payment system, this will create serious potential risks and even disrupt smooth operation of the payment system. This failure ultimately creates a contagion risk that creates a systemic disturbance. Bank Indonesia is also developing mechanisms and arrangements aimed at reducing risks in an increasingly increasing payment system.

Namely by establishing a payment system that is real time and is known as the RTGS system (Real Time Gross Settlement) which can further improve the security and speed of the payment system. As the authority on the payment system, BI itself has information and expertise in identifying potential risks in its payment system.

Then fourthly, with its function in research and monitoring, Bank Indonesia can access information deemed to threaten financial stability. Through macroprudential monitoring, Bank Indonesia can monitor financial sector vulnerabilities and detect potential shocks that could impact financial system stability.

Through research, Bank Indonesia can develop macroprudential instruments and indicators to detect vulnerabilities in the financial sector. The results of this research and monitoring can then become a recommendation for the relevant authorities in choosing the right steps to reduce disruptions to the financial sector.

Fifth, Bank Indonesia has a function as a safety net in the financial system through the function of the central bank, lender of last resort (LoLR). The LoLR function itself is the traditional role of Bank Indonesia as the central bank in managing crises in order to avoid instability in the financial system.

Its function is to act as LoLR which includes providing liquidity under normal conditions as well as during a crisis. This function is also only given to banks that have faced liquidity problems and of course there is a potential for a systemic crisis impact.

Under normal conditions, the LoLR function can be applied to banks that have experienced temporary liquidity problems so that they still have the ability to repay. To carry out its function as LoLR, Bank Indonesia is required to avoid moral hazard. Therefore, systemic risk considerations and strict conditions must be applied to provide this liquidity.


You can learn about Central Bank Policy: Theory & Practice
by Perry Warjiyo, Solikin M. Juhro

This is an explanation regarding the meaning of a central bank, complete in writing with its objectives, duties and authorities to carry out all of its responsibilities. In this discussion it is very important to be able to increase our knowledge and insight related to the central bank, especially if our company is currently able to relate to conventional banks which are under the control of the central bank.

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