Get premium membership and access revision papers with marking schemes, video lessons and live classes.

Processing. Please wait.

Methods in which central bank controls credit

Answer Text:
Methods in which central bank controls credit.
-Bank rates:
They may increase or decrease the interest rate at which they lend to the commercial banks to enable them increase or decrease the rate at which they lend money to their customers in the economy .
-Open Market Operations (OMO):
This is where they regulate the supply of money in the economy by either selling or buying the government
securities (treasury bills or bonds) in the open market. That is when they want to increase the supply in the economy, they buying the securities from the members of the public who had bought them to increase more supply of money in the economy.
When they want to reduce the amount of money in circulation they will sell the government security to the public in the open market, to mop up/reduce the excess supply in the economy.
-Cash/liquidity ratio requirement:
Here the central bank expect the commercial bank to keep a certain proportion of their total deposits in form of cash to enable them meet their daily needs, while the rest are held in liquid assets. This proportion can be reduced by the central bank to reduces the amount of money held by the commercial banks in order to reduce the amount of money spent by the commercial banks
in cash, reducing the amount of money in supply, or they may increase the proportion to be held by the commercial banks to enable them increase the amount of money they spent in cash, increasing the amount of money in supply
-Compulsory deposit requirements
The commercial banks are required to maintain a certain amount of deposits with the central bank which will be held in a special account where the money stays frozen.
-Selective credit control:
The central bank may issue a special instruction to the
commercial bank and other financial institution only to lend more in a particular sector to control the amount of money reaching the economy.
-Directives:
The central bank may issue a directive to the commercial banks on the interest rate they should charge on their lending and to increase or reduce the margin
requirement for borrowing to make it harder or easier for the customers to obtain loan.
-Request (Moral suasion):
The central bank may appeal to other financial institutions to exercise restrain in their lending activities to the public to help in controlling the money supply