(a) Define Central Bank.
(b) Outline three ways in which the Central Bank of a country can reduce money supply.
(c) Explain how the Central Bank plays its role as:
(i) banker to the government; (ii) banker to commercial banks; (iii)lender of last resort.
(a) The Central bank is the government owned financial institution that controls and supervises the entire monetary system of a country.
b(i) Open market operations:
This involves the sale and purchase of government securities in the open market. When there is too much money in circulation, the Central bank sells government securities such as treasury bills through the commercial banks to the pubic. This reduces money in the hands of the public, thus reducing money supply.
(ii) Bank rate:
This is the rate at which the Central bank lends to commercial banks and discounts bills of exchange. When money supply increases, the Central bank increases the bank rate and so borrowing from the Central bank by commercial banks is at a high interest rate. Thus, commercial banks will raise the interest rates on loans given to the public. The members of the pub- lic get discouraged by the high interest rate charged by commercial banks thus reducing lending and money supply.
(iii) Cash ratio:
This is the percentage of all deposits that commercial banks are required by law to keep against customers withdrawals. If money supply goes up, the Central bank raises the cash ratio and so less money is available as loans to the public thus reducing money sup- ply.
(iv) Special deposits:
This is an extra amount that commercial banks are supposed to keep with the Central bank. To reduce money supply, the amount paid as special deposit is increased thereby reducing the ability of the commercial banks to grant more loans.
(v) Directives:
When there is an increase in money supply, commercial banks are asked to limit their lending and give loans to specified sectors of the economy.
c(i) Banker to the government:
The Central bank operates both internal and external banking business on behalf of the government. It keeps government accounts, makes payments and receives cash on behalf of the government. It borrows from the public by selling securities on behalf of the government.
(ii) Banker to commercial banks: The Central bank accepts deposits from the commercial banks and keeps a percentage of their deposits as re- serves. It offers a clearing house system by settling inter-bank indebtedness.
(iii) Lender of last resort:
When commercial banks are in crisis, it is the duty of the Central bank to bail them by lending these banks money. This helps to keep them going since they cannot fold up due to liquidity problems.
Contributions ({{ comment_count }})
Please wait...
Modal title
Report
Block User
{{ feedback_modal_data.title }}