Central bank acts as the banker to the banks in three ways :
custodian of the cash reserves of the commercial banks;
as the lender of the last resort; and
as clearing agent.
As a custodian of the cash reserves of the commercial banks, the central bank maintains the cash reserves of the commercial banks. Every commercial bank has to keep a certain percent of its cash reserves with the central bank by law.
As Lender of the Last Resort. (a) As banker to the banks, the central bank acts as the lender of the last resort. (b) In other words, in case the commercial banks fail to meet their financial requirements from other sources, they can, as a last resort, approach to the central bank for loans and advances.
The central bank assists such banks through discounting of approved securities and bills of exchange. (c) As Clearing Agent
(i) As the custodian of the cash reserves of the commercial banks, the central bank acts as the clearing house for these banks.
(ii) Since all banks have their accounts with the central bank, the central bank can easily settle the claims of various banks against each other simply by book entries of transfers from and to their accounts.
(iii) This method of settling accounts is called Clearing House Function of the central bank
