How does the Central Bank exercise control over commercial banks?
Explanation
The Central Bank exercises control over commercial banks in the following ways:
(i) Open market operation: The Central bank applies open market operations with a view to regulating the volume of money in circulation. By this operation, the central bank purchases or sells government securities to the commercial banks.
(ii) Special directives: This is issued to commercial banks to restrict or liberalize their loan policy to business men.
(iii) Bank rate: The bank rate is the rate of interest charged by the central bank for discounting bills. The Central Bank controls the commercial banks by raising or lowering the bank rate as the need arises.
(iv) Moral suasion: The Central Bank sometimes engages in friendly dialogue with the other banks in order to agree on how banking activities are to be carried out. It is a gentle appeal made by the central bank to the commercial banks to restrict their expansion of credit to the public and to be selective in their lending operations.
(v) Cash ratio: The commercial banks are required by law to keep a specified proportion of their total deposits with the Central Bank in the form of bank reserves, usually 25% of their total deposits. The size of the reserve can be raised or lowered according to the economic exigencies of the country.
(vi) Special deposits: The Central Bank has the right to require the other banks to make special deposits with it. This type of forced deposits has the effect of limiting the liquid cash available to the banks for other operations.