Agencies that Regulate Financial Markets

Back to: ECONOMICS SS3

 

Welcome to class! 

In today’s class, we will be talking about agencies that regulate financial markets. Enjoy the class!

Agencies that Regulate Financial Markets

• Central Bank of Nigeria (CBN)
• Nigeria Deposit Insurance Corporation (NDIC)

CENTRAL BANK OF NIGERIA

The central bank is the apex financial institution in a country which is responsible for the management, supervision and control of monetary affairs and financial institutions of the country.

Before the independence of most of the British colonized countries of West African (Nigeria, Ghana, Sierra Leone, and the Gambia), the West African Currency Board (WACB) with its headquarters in London was responsible for all monetary matters.

As soon as each country gained or approached political independence, it established her own central bank. A central bank was established in Ghana in 1957, in Nigeria in 1959, in Sierra Leone in 1964 and the Gambia in 1971.

FUNCTION OF THE CENTRAL BANK

1. It serves as banker to the government: The Central Bank keeps all the revenue accounts of the government and makes payment out of it on behalf of the Government. More importantly, it leads to the government and also manages the National Debt i.e. the government’s external and internal borrowings.
2. Issuing of Currency: The Central Bank is the only authority empowered by law to issue all paper money (banknotes) and coins in the country
3. It is a bankers’ bank: The Central Bank serves as a bank to commercial banks, meaning that by law, the commercial banks are required to keep the account (deposits) with the central bank
4. The Central Bank serves as the clearinghouse for the settlement of interbank debts
5. Lender of last resort: The Central Bank lends money to commercial banks in serious needs to enable them to satisfy or settle their customers demand cash
6. Adviser to the Government: The Central Bank advises the government on monetary matters such as on methods of raising loans particularly foreign loans.
7. Management of the National Debt: The arrangements for new borrowings as well as the servicing and rescheduling of existing debts are handled by the Central Bank
8. Foreign Monetary Transactions: The Central Bank holds and manages the foreign exchange reserve and advises the government on the trends.
9. Carrying out or implementation of the government’s Monetary Policies.
10. The Central Bank maintains close contact with other international financial institutions e.g. IMF, IBRD (World Bank), ADB etc. 

MONETARY POLICY

Monetary Policy is mainly concerned with varying the money supply in the economy.

The central bank uses some measures like the bank rate, open market operators, special deposits, directives, cash ratio, etc, all to regulate the volume of money in the economy; thereby checking inflation or deflation when necessary.

INSTRUMENTS OF MONETARY POLICY / OR HOW THE CENTRAL BANK CONTROL THE COMMERCIAL BANKS

The government carries its monetary policy through the central bank. The central bank itself enforces the monetary policy through the various ways by which it controls the ability of the commercial bank to create credit

The central bank controls the commercial bank to implement government monetary policy through the following instruments

1. Bank Rate/Discount Rate: This is the rate of interest the central bank charges commercial banks and other financial institutions for discounting their bills or the rate at which it lends money to them. The bank rate influences other interest rates in the economy. A higher bank rate leads to a higher interest rate. If there is inflation, the central bank will increase the bank rate. This will curtail the lending power of the commercial banks by making the cost of borrowings by bank customers to be very exorbitant

If there is deflation in the economy, the Central Bank will reduce the bank rate thereby allowing the commercial banks to create more credit, increasing the supply of money in the economy.

2. Liquidity Ratio/Cash Reserve Ratio: This is a requirement by law to the commercial banks to keep a certain percentage of their total cash / liquid assets or deposits with the central bank. In Nigeria for example the Liquidity Ratio is 20%. The central bank uses this ratio in increasing or decreasing the amount of money in circulation. Therefore the higher the cash reserve ratio, the lower the power of commercial banks to grant credit/loans to their customers. This policy of increasing the cash reserve ratio is therefore used to control inflation. The reverse is also true.
3. Special Deposit: This is an instruction to the commercial banks to keep with the central bank special deposits over and above their statutory requirements thereby, curtailing the ability of the commercial banks to create credit. This instrument is used when the use of the cash reserve ratio alone is not adequate to keep down the rate of inflation.
4. Open Market Operations (OMO): This is the method of buying and selling of securities (Treasury Bills) to the public and the commercial banks by the central bank to alter the volume of money in circulation and also to vary the ability of the commercial banks to create credit.

If the Central Bank feels that the money in circulation is too small and wants to increase it, it will buy securities in the open market paying with its own cheque. On the other hand, if the volume of money in circulation is too much and the Central Bank wants to reduce it, it will simply sell securities in the open market to the general public and the commercial banks thereby withdrawing a lot of money from the economy.

5. Special Directives: These are special instructions which the central bank gives to commercial banks and other financial institutions regarding the size of the loan to give and the areas (sectors of the economy) to which it should direct bank lending e.g. agriculture, manufacturing etc.
6. Moral Suasion: This is persuasion based on moral grounds not with the use of force of law by the central bank to the commercial bank as to the kind of lending policy they should adopt regarding the expansion or contraction of the money supply. Failure to comply can thereafter necessitate force of law. Directives and moral suasion are widely used in developing countries.
7. Funding: This is the conversion of short term government securities to long term securities.

For example, Treasury Bills (of 91 days maturity) could be converted to bonds (long term securities). If the central bank feels that the conditions of the economy have not yet improved for the short term loans to be repaid eg if there is inflation, the short term securities may be converted to long term securities.

EVALUATION

1. Define Central Bank.
2. Describe five instruments used by the Central Bank to control the money supply.

 

In our next class, we will be talking about Functions and Role of Regulatory Agencies.  We hope you enjoyed the class.

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