(a) What is a commercial bank? [4 marks]
(b) Describe any four ways by which the Central Bank controls the amount of credit given by the commercial bank [16 marks]
Explanation
(a) A commercial bank is a financial institution, usually established as a joint-stock company with the aim of making profit. It usually grants short-term and medium
term loans.
(b) The various ways by which the central bank controls the amount of credit given by the commercial banks are:
(i) Through the manipulation of the Bank Rate: If the central bank wants to encourage the commercial banks to lend more it would reduce the Bank Rate. If it wants to
discourage the commercial banks from lending it would raise the Bank Rate
(ii) Open Market Operations: The central bank sells securities on the open market to reduce the reserves of the commercial banks and so limit their ability to lend. On the other hand if it wants to encourage the commercial banks to lend, it buys securities on the open market to Increase the cash reserves of the commercial banks.
(iii) Special deposits: By calling on the commercial banks to make special deposits With it, the central bank reduces the reserves the commercial banks are free to use to give credit.
(iv) Through the manipulation of the cash minimum reserve ratio/liquidity ratio: The cash ratio is raised when it is desired to discourage lending by the commercial banks. On the other hand it is reduced when it is desired to encourage them to lend
(v) Directives/Selective credit control: The central bank has authority to give direct instructions to the commercial banks as to whether or not they should increase their lending. Sometimes it gives directives as to sectors of the economy that should be favored in granting loans.
(vi) Moral suasion: Sometimes by merely announcing to the commercial banks its policy on lending, the central bank succeeds in getting the commercial banks to behave as expected
(vii) Funding: The central bank can convert short- term securities into long-term securities and so prevent an increase in the reserves of the commercial banks.