Central bank and their function. Definition: The central bank is the highest financial institution in a country which carries out the monetary policy of the government.
It is the sole authority in the banking industry which acts as a banker to the government and the commercial banks. Central bank controls and regulates the supply of money.
Most countries have their central banks, which work closely with the government to have means of influencing the credit policy of commercial banks, e.g. Central Bank of Nigeria.
Historical development of the Central Bank in West Africa
In West Africa, before independence, the West African Currency Board (W.A.C.B.) was the highest financial institution which performed the functions of the central bank. The board; controlled the issue of currency in the Anglophone-speaking countries of West Africa, which are Nigeria, Ghana, Sierra Leone and The Gambia.
The goal was to keep the currencies of these West African nations at par with the pound sterling. After independence, the countries set up their central banks to ensure rapid economic development.
Characteristics of central banks
- It is not profit-oriented.
- There is only one central bank in a country.)
- It is the highest financial institution.
- It is established by the Act of Parliament.
- It is owned by the government.
- There is no transaction with private individuals
Functions of the Central Banks
- Banker to the government: This is an agent and banker. It controls public accounts, receives revenue on behalf of the government and makes payments from this account. The bank also obtains loans on behalf of the government.
- Issuance and control of currency: The Bank has the right to order the printing of the currency and the issuance of it. It controls the circulation of currency, exchange of bad notes for new ones, and sees to the destruction of the bad notes.
- Banker’s bank: This acts as a banker to the banks by ensuring that the banks open accounts with it to facilitate the clearing of cheques. This helps the commercial banks to have similar facilities to offer to their customers.
- Lender of last resort: The bank has a duty to assist the banking system when the banks are in financial difficulties so that they can withstand the strain of excessive demands. In some countries, the banks can borrow directly from the central bank.
- Foreign exchange transactions The bank holds the foreign reserve of country y, and this helps in enforcing foreign exchange control, which is set up to purchase and sell foreign currencies.
- Management of national debt: It is the bank responsible for the management of the national debt of the country. It also acts as a clearing house for other banks.
- Maintenance of external reserves: The central bank is also responsible for the maintenance of external reserves country.
- Responsible for monetary policy The Central bank is responsible for the monetary policies of the country. It can use both the expansionist and restrictions policies to control the quantity and value of money in circulation so as to influence the level of production and distribution of the national income.
- Formulation of rules and regulations guiding the banking industry: The central bank controls, regulates and supervises the components of the banking system. the It lays down rules and regulations to be followed by all banks: to ensure smooth operations.
- External business: The central bank acts as an agent of the country by relating with other countries and international financial institutions like the IMF and World Bank.
How the Central Bank Controls the Commercial Banks
The central bank uses the following instruments to control commercial banks and the supply to regulate these instruments:
Open Market Operation (OMO):
Open market operation is the purchase or sale of government securities in the open market to expand the volume of money in circulation. The central bank applies this poCommercialaim of regulating the volume of money in circulation.
When there is too much money in circulation, the central bank will sell securities. But in order to expand the volume, it buys securities.
- Liquidity ratio or cash ratio: Commercial banks are mandated by the government to keep a special proportion, e.g. 25%, of their total deposit with the central bank in order to control the volume of credit. The size can be expanded or contracted depending on the economic condition of the nation.
- Bank rate: The bank rate is the minimum rate of interest charged by the central bank for discounting bills of exchange. By lowering or raising the rate, the central bank can control the activities of the commercial banks. When the rate increases, loan to the public (customers) reduces, while a fall in the rate will encourage more loans.
- Special directives: The central bank can issue directives or specific instructions to commercial banks and other financial institutions to restrict their lending or credit policy or on the direction to which loaning should follow. They will be told to direct their funds to sectors which are in need of
- Special deposit: A special deposit is also an instrument of monetary policy which is used to restrict lending. The central bank can order the commercial banks to have special deposits, usually a percentage of the banks’ deposits, to be made with it. This is intended to control credit and is often used during the period of inflation to reduce cash with banks. The central bank will mandate the commercial banks to keep special deposits over the statutory requirement.
- Moral suasion: The central bank can make an appeal to the commercial banks to restrict or expand the level of credit involved. Moral suasion is not based on the use of force but an appeal to restrict or expand the lending policy.
Difference between Central Bank and Commercial Banks
| Central Bank | Commercial Bank | |
| 1 | The central bank is owned by the government. | They accept deposits from the public |
| 2 | It formulates and executes monetary policies. | They do not formulate monetary policies |
| 3 | It is accountable to the federal government. | They are usually owned by the public or government |
| 4 | It is accountable to the federal government. | They are accountable to shareholders |
| 5 | It manages the national debt | They do not manage national debt |
| 6 | It serves as a banker to the banks and governments | They do not issue currency |
| 7 | Only one central bank exists in a country. | They are set up to make a profit |
| 8 | It is responsible for issuing currency. | They are set up to make profit |
| 9 | They do not manage the national debt | They serve as bankers to individuals and institutions |
| 10 | It is establishment by Act of parliament | They are established by incorporation |
The central bank is completely involved in both the money and capital markets. It makes money available to other institutions involved in both money and capital markets as a lender of last resort. This means that commercial banks and other institutions involved in money and capital markets can go to the central bank to raise loans when they are short of money or have financial difficulties.
Type of economic system: The type of economic system adopted by the government determines the nature of economic activities that will take place in that country. For example, Nigeria has a free economy in which private individuals can participate in economic activities.
Low capital small-scale: The capitalized to set up private enterprises is usually very small, hence private enterprises are in existence
Favourable market: The availability favourable market for finished goods makes the proliferation of small-scale enterprises flourish in many West African countries.
High level of efficiency: Private enterprises are known to be more efficient and management than public enterprises and these account for their large number in the economy.
Favourable legal environment: The enabling laws which govern the enabling of F Private enterprises are quite favourable. This makes is easy and interesting for many entrepreneurs to go into the private business.
Availability of credit facilities: The availability 0f credit facilities to private individuals enables them to set up private enterprises.
Establishment of individual estates: The establishment of individual the estates by government also encourages the proliferation of private enterprises in many West African countries.
Existence of official corruption in public enterprises: The existence of official corruption in public enterprises discourages the government from further investment in public enterprises, thereby giving way to the proliferation of private enterprises in many West African countries.
Originally posted 2023-10-10 08:13:30.