Welcome to myschoollibrary! We are still on the topic Financial Institutions. If you have been following up our lessons, you would know that the topic is broad. So our attention today will be focused on another aspect of it which is ” Central Bank”. Do have a pleasant moment studying with us.

Lesson Note

Subject: Economics

Topic: Financial Institutions

Sub topic: Central Bank.

Learning Objectives: By the end of the lesson, the learners should be able to:

  1. Explain the term Central bank;
  2. State the characteristics of central bank;
  3. Give a brief historical background of central bank in their region ;
  4. State the functions of central bank;
  5. Mention and explain the various ways central bank controls commercial banks;
  6. Identify the differences between central bank and commercial banks.

Discussions

CENTRAL BANK

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 banker to the government and the commercial banks. Central bank controls and regulates the supply of money. Most countries have their own central banks, which work closely with the government in order to have means of influencing the credit policy of commercial banks, e.g Central Bank of Nigeria.

Historical development of central bank in West Africa

In West Africa, before independence, the West Africa 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 Anglo speaking countries of West Africa, which are Nigeria, Ghana, Sierra Leone and the Gambia. The goal was to keep 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.
The Central Bank of Nigeria was then established in 1959. It was charged with the management of the country’s currency. It supervises and co-ordinates other financial institutions in Nigeria to facilitate economic development. The report submitted by Mr. J.B Loyins in August 1957 culminated in the establishment of the Central Bank of Nigeria.

Characteristics of central bank

i. Central bank is not profit oriented.
ii. There is only one central bank in a country.
iii. It is the highest financial institution.
iv. Central bank is established by the Act of Parliament.
v. It is owned by the government.
vi. There is no transaction with private individuals.

Functions of the Central Banks

(1) Banker to the government: Central bank is an agent and banker to the government. It controls public account, receives revenue on behalf of the government and makes payment from this account. Central bank also obtains loan on behalf of the government.
(2) Issuance and control of currency: The central 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.
(3) Banker’s bank: The central bank acts as banker to the banks by ensuring that the banks open accounts with it in order to facilitate clearing of cheques. This helps the commercial banks to have similar facilities to offer to their customers.
(4) Lender of last resort: The central 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.
(5) Foreign exchange transaction: The central bank holds the foreign reserve of a country and this helps in enforcing foreign exchange control which is set up to purchase and sell foreign currencies.
(6) Responsible for the monetary policy: The central bank is responsible for the money you 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.
(7) Maintenance of external reserves: The central bank is also responsible for the maintenance of external reserves of the country.

How Central Bank Controls the Commercial Banks

The Central bank uses the following instruments to control commercial banks and the supply of money in the economy. These instruments include;
(1) Open Market Operation: Open Market operation is the purchase or Saturday of government securities in the open market to expand or restrict the volume of money in circulation. The Central bank applies this policy with the aim 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.
(2) Liquidity ratio or cash ratio: The 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 tge volume of credit. The size can be expanded or contracted depending on the economic condition of the nation.
(3) Bank rate: Bank rate is the minimum rate of interest charged by the central bank for discounting bill 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) of reduces, while a fall in the rate will encourage more loans.
(4) Special directives: The central bank can issue directives or specific instructions to the 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 investment.
(5) Special deposit: 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 deposit over the statutory requirement.
(6) Moral suasion: The central bank can make an appeal to the commercial banks to restrict or expand the level of credit to the public. Moral suasion is not based on the use of force but an appeal to restrict or expand the lending policy.

Differences between Central Bank and Commercial Banks

Central Bank
Commercial Bank

i.Central bank does not accept deposit from the public
But commercial banks do accept deposits from the public

ii. Central bank formulates and executes monetary policies
While commercial banks do not formulate monetary policies.

iii. Central bank is owned by the government alone while commercial banks are usually owned by the public or government.

iv. Central bank owes accountability to the federal government whereas commercial bank is accountable to shareholders.

v. The central bank is responsible for issuing of currency however commercial banks do not issue currency.

Done studying? Use the questions below to test your understand of the lesson.

  1. What do you the understand by the term Central bank?
  2. State the characteristics of central bank.
  3. Give a brief historical background of central bank in your region using west Africa as case study.
  4. State the functions of central bank.
  5. Mention and explain the various ways central bank controls commercial banks.
  6. What are the differences between central bank and commercial banks?

Did you answer those questions correctly? Great!!

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References

Ande, C.E. (2012). Essential Economics for senior secondary schools. Tonad Publishers.

Ogwumike, F.O., Ekpenyong, D., Olofin, O., & All, O.M. (Ed.). (2010). MacMillan Senior Secondary Economics. MacMillan Nigeria Publishers.

Note: itsmyschoollibrary considers the above academic resources appropriate and so were sourced for the development of this lesson. Hence no part of these referenced materials should be lifted from this blog without appropriate permission from the various sources.