Theory question 109
Financial InstitutionsSection B
How does the central bank exercise control over commercial banks?
Show the model answer
Model answer
Methods:
1. Bank rate/monetary policy rate – raising it makes borrowing dearer and reduces lending.
2. Open market operations – selling securities reduces banks' cash; buying increases it.
3. Cash reserve ratio – raising it reduces banks' ability to create credit.
4. Liquidity ratio requirements.
5. Special deposits called from commercial banks.
6. Selective credit control – directing loans to priority sectors.
7. Credit ceilings.
8. Moral suasion – persuading banks to follow policy.
9. Licensing, supervision and bank examination; prudential guidelines.
Explanation
Explain how each tool affects banks' lending.