What central banks are and how they work

When the news says that “the central bank raised interest rates”, it is talking about the decision of a public institution that affects the cost of almost every loan in the country. The same body issues the banknotes you use, holds the international reserves and supervises the banks.

This article explains what a central bank is, what its functions are, how monetary policy works and what changed with the independence of the Banco Central do Brasil (BC, Brazil’s central bank). The overview of how banks, capital markets and payments fit together is in the companion article on how the modern financial system works.

What a central bank is

A central bank is the monetary authority of a country or a group of countries. According to the International Monetary Fund (IMF), its main task is to pursue price stability, understood as low and stable inflation (IMF, “Monetary Policy and Central Banking”).

In Brazil, the BC was created by Law No. 4,595/1964. Complementary Law No. 179/2021 set out its objectives. The fundamental one is “to ensure price stability”. Without prejudice to it, the BC must also safeguard the stability and efficiency of the financial system, smooth fluctuations in economic activity and foster full employment (Article 1).

The functions of Brazil’s central bank

The BC itself summarizes its tasks on five fronts (BC, institutional page):

• low and stable inflation: it uses monetary policy to preserve the currency’s purchasing power;
• a safe and efficient financial system: it regulates and supervises institutions so that they have enough capital for their commitments;
• the government’s bank: it holds the government’s most important accounts and is the custodian of the international reserves;
• the bankers’ bank: financial institutions must have accounts at the BC, which monitors these balances so that transactions flow;
• issuer of money: it manages the currency in circulation, that is, the supply of banknotes and coins to the public.

Issuing currency

Brazil’s Constitution says that the federal government’s power to issue currency “shall be exercised exclusively by the central bank” (Federal Constitution, Article 164). The same article prohibits the BC from lending, directly or indirectly, to the National Treasury and to any body that is not a financial institution. It may, however, buy and sell Treasury securities to regulate the money supply or the interest rate.

This separation matters. It prevents the government from paying its expenses by asking the central bank directly for new money. As we will see below, protection against pressure to finance deficits is one of the BIS’s arguments in favor of independence.

The bankers’ bank and lender of last resort

Under Law No. 4,595/1964 (Article 10), the BC has exclusive responsibility, among other tasks, for receiving banks’ reserve requirements and carrying out rediscount and lending operations with financial institutions. The reserve requirement is the portion of deposits that banks must keep idle at the BC. A rediscount is a loan the BC makes to a bank that needs short-term liquidity (available cash).

This liquidity support function is known as lender of last resort. It exists because a bank can be sound and still face a run on deposits. Complementary Law No. 179/2021 added that the BC must notify the National Monetary Council (CMN) in advance whenever one of these operations may have a significant fiscal impact.

Monetary policy: how interest rates reach your life

Monetary policy is the set of central bank actions that affect the cost of money (interest rates) and the amount of money available in the economy. In Brazil, it operates within the inflation-targeting regime, adopted in 1999 (BC, inflation targets).

Who sets the target and who pursues it

The division of roles is in the law. LC 179/2021 says that monetary policy targets are set by the CMN and that the BC has exclusive responsibility for conducting the policy needed to meet them (Article 2). The index used is the IPCA, Brazil’s official consumer price index, calculated by IBGE (the national statistics institute).

Since January 2025, the so-called continuous target has been in effect, created by Decree No. 12,079/2024. Inflation accumulated over 12 months is compared with the target every month, not just in December. According to the BC, the target set by the CMN is 3.00%, with a tolerance band of 1.5 percentage points up or down. The target is considered missed when inflation stays outside this band for six consecutive months (information checked on October 8, 2026).

When that happens, the decree requires the BC to explain publicly the causes, the measures to bring inflation back and the expected timeframe, through a note in the Monetary Policy Report and an open letter to the finance minister.

The Copom and the Selic rate

The interest rate decision lies with the Monetary Policy Committee (Copom), made up of the BC’s governor and directors. According to the BC, the Copom meets every 45 days and sets the target for the Selic rate, Brazil’s benchmark interest rate. The Selic is the average rate of trades in National Treasury securities registered in the system of the same name. All votes are disclosed, and the minutes are released within four business days.

After the meeting, the BC acts in the market daily, buying and selling federal government bonds, to keep the rate close to the value decided. These are open market operations.

Why the Selic affects everything

The Selic serves as a reference for the other interest rates in the economy. The IMF describes the chain: the central bank’s operations affect short-term interest rates, which pass through to longer-term rates and then to economic activity. Lowering rates is loosening monetary policy. Raising them is tightening it (IMF).

For you, the consequence is concrete. Higher benchmark rates tend to make financing more expensive and to increase the returns on investments linked to them. Lower rates tend to do the opposite. The effect is neither immediate nor the same for every product, and this article makes no forecast about future decisions.

Independence: what changed with LC 179/2021

Before 2021, the BC governor held a post with the rank of minister of state, without a fixed term; LC 179/2021 turned this post into a position of a special nature (Article 9). The same law turned the BC into an “autarchy of a special nature”, not tied to any ministry, without oversight or hierarchical subordination, with technical, operational, administrative and financial autonomy (Article 6).

The central points of the law:

• fixed four-year terms for the governor and the eight directors, nominated by the President of the Republic and approved by the Senate (Articles 3 and 4);
• staggered terms: the governor’s term begins on January 1 of the third year of the President’s term, and the directors’ terms begin in different years. That way, no government replaces the entire board at once;
• dismissal only in specified cases: at their own request, due to incapacitating illness, upon conviction for certain crimes or for proven and recurrent insufficient performance. In the latter case, the proposal comes from the CMN and requires approval by an absolute majority of the Senate (Article 5);
• accountability: the BC governor must present inflation and financial stability reports to the Senate, at a public hearing, every six months (Article 11);
• cooling-off period: after leaving office, former officials may not work for financial system institutions for six months (Article 10).

Independence does not mean the BC chooses the target. The target is still set by the CMN, chaired by the finance minister. The BC chooses the means.

Why central banks are independent

The Bank for International Settlements (BIS), an organization of central banks, treats independence as part of the arrangement that sustains trust in the value of money. In a January 2026 speech, General Manager Pablo Hernández de Cos said that independence allows decisions based on the long term, not on short-term political pressures. He also said it protects central banks from pressure to finance government deficits (BIS, 2026).

In the same speech, he stressed that accountability to the legislature and to society is the fundamental counterpart of independence. A year earlier, then General Manager Agustín Carstens listed six principles for central bank statutes: mandate, instruments, accountability, budgetary sufficiency, governance and relationship with other government bodies (BIS, 2025).

The issue is not a matter of political consensus, and the design of independence varies from country to country. These are the positions of an organization of central banks, not a verdict.

Central banks and digital money

Central banks also operate payment infrastructures. In Brazil, the BC created and operates Pix, the country’s instant payment system (Pix: architecture and how it works). Several are studying digital versions of their own currency, CBDCs. The Brazilian case is in Drex: proposal, architecture and project status, and the comparison with private currencies in stablecoins versus central bank digital currencies.

Takeaways

• The central bank issues currency, carries out monetary policy, is the bank of the government and of the banks, and safeguards the soundness of the financial system.
• In Brazil, the CMN sets the inflation target and the BC pursues it mainly through the Selic, decided by the Copom every 45 days.
• The independence created by LC 179/2021 gives the board fixed, staggered terms, but comes with accountability obligations to the Senate and to society.