A central Bank is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. The central bank often also oversees the commercial Banking system within its country. A central Bank is distinguished from a normal commercial bank because it has a monopoly and creating the currency of that nation, which is usually that Nations legal tender. Central Bank of Kenya is the highest Banking institution in the country and responsible for ensuring the smooth working of banking sector and other financial institutions.
Central Bank differs from commercial banks in that it does not engage in ordinary banking activities e. g. accepting deposits from the general public. It is owned by the government while commercial banks are owned by shareholders. CBK usually implements certain government policies. OBJECTIVES OF CENTRAL BANK OF KENYA i. To formulate and implement monetary policy directed to achieving and maintaining stability in the general level of prices. ii. The Bank fosters the liquidity, solvency and proper functions of a stable market based financial system. iii.
Support the economic policy of the government including its objectives for growth and employment. iv. Formulate and implement foreign exchange policy v. Hold and manage its foreign exchange reserves. vi. License and supervise authorized dealers vii. Formulate and implement such policies as best promote the establishment, regulations and supervisions of efficient and effective payment, clearing and settlement systems. viii. Act as banker and advisor to and as fiscal agent of the government. ix. Issue currency notes and coins. FUNCTIONS OF CENTRAL BANK i. Implementing monetary policy ii.
Determining interest rates. iii. Controlling the Nations entire money supply iv. The Government banker and the bankers bank. v. Managing the country’s foreign exchange, gold reserves and also the government stock register. vi. Regulating and supervising the banking industry. vii. Setting the official interest rate used to manage both inflation and the country’s exchange rate and ensuring that this rate takes effect via a variety of policy mechanism. MONETARY POLICY Central banks implement a country chosen monetary policy. This involves establishing what form of currency the country may have.
In countries with fiat money, monetary policy may be used as a shorthand form for the interest rates targets and other active measures undertaken by the monetary authority. GOALS OF MONETARY POLICY i. Price Stability: Unanticipated inflation leads to lender losses. Normal contracts attempt to account for inflation. Efforts are successful if monetary policy is able to maintain steady rate of inflation. ii. High Employment: The movement of workers between jobs is referred to as frictional unemployment. All unemployment beyond frictional unemployment is classified as unintended unemployment.
Reduction in this area is the target of macroeconomic policy. iii. Economic Growth: Economic growth is enhanced by investment in technological advances in production. Encouragement of savings supplies funds that can be drawn upon for investment. iv. Interest Rate Stability: Volatile interest and exchange rates generate costs to lenders and borrowers. Unexpected charges that cause damage, making policy formulation difficult. v. Conflict Among Goals: Goals frequently cannot be separated from each other and often conflict. Costs must therefore be carefully weighted before policy implementation.
vi. Financial Market Stability. vii. Foreign Exchange Market Stability. CURRENCY ISSUANCE Many central Banks are ‘Banks’ in the sense that they hold assets (foreign exchange, Gold and other financial assets) and liabilities. Central banks generally earn money by issuing currency notes and selling them to the public for interest bearing assets such as government bond. INTEREST RATES INTERVENTIONS Typically a central bank controls certain types of short term interest rates. These influence the stock and bond markets as well as the mortgage and other interest rates. POLICY INSTRUMENT
The main monetary policy instruments available to central banks are open market operation, bank reserve requirements, interest rates policy, re-lending and re-discount and credit policy. To enable open market operations, a central bank must hold foreign exchange reserves and official gold reserves. It will often have some influence over any official or mandated exchange rates. INTEREST RATES The most visible and obvious power of many modern central banks is to influence market interest rates. The actual rate that borrowers and lenders receive on the market will depend on credit risk, maturity and other factors.
A typical central bank has several interest rates or monetary policy tools it can set to influence markets; a. Marginal Lending Rate- a fixed rate for institutions to borrow money from the central bank b. Main Refinancing Rate- the publicly visible interest rate the central bank announces. It is also known as minimum bid rate and serves as a bidding floor for refinancing loans. c. Deposit Rate- the rate parties receive for deposits at the central bank. These rates directly affect the rates in the money market and the market for short term loans. OPEN MARKET OPERATIONS.
Through open market operations, a central bank influences the money supply in an economy directly. Each time it buys securities, exchanging money for the security, it raises the money supply, and conversely selling of securities lowers the money supply. Buying of securities thus amount to printing news money while lowering supply of the specific security. The main open market operations are; a. Temporary lending of money for collateral securities b. Buying and selling securities c. Foreign exchange operations such as forex swaps CAPITAL REQUIREMENTS
All banks are required to hold a certain percentage of their assets as capital, a rate which may be established by central bank or the banking supervisor. Capital requirements may be considered more effective than deposits or reserves requirements in preventing indefinite lending. Bank cannot extend another loan without acquiring further capital on its balance sheet. RESERVE REQUIREMENTS Many Banks are required to hold a percentage of their deposits as reserves. Loan activity by banks plays a fundamental role in determining the money supply. Currency and banks reserves together make up the monetary base.
EXCHANGE REQUIREMENTS To influence the money supply, central banks may require that some or all foreign exchange receipts be exchanged for the local currency may be market based or arbitrarily set by the bank. The recipient of the local currency may be allowed to freely dispose of the funds, required to hold the funds with the central bank for some period of time, or allowed to use the funds subject to certain restrictions. In this method, money supply is increased by the central bank when it purchases the foreign currency by issuing (selling) the local currency.
The central bank may subsequently reduce the money supply by various means, including selling bonds or foreign exchange interventions. MARGIN REQUIREMENTS AND OTHER TOOLS Central Banks may regulate margin lending where by, individuals or companies may borrow against pledged securities. The margin requirement establishes a minimum ratio of the value of the securities to the amount borrowed. Central banks often have requirements for the quality of assets that may be held by financial institutions, these requirements may act as a limit on the amount of risk and leverage created by financial systems.
These requirements may be directed, such as requiring certain assets to bear certain minimum credit rating or indirect by the Central Bank lending to counterparties only when security of a certain quality is pledged as collateral. BANKING SUPERVISION AND OTHER ACTIVITIES Central Bank through its subsidiaries control and monitors the banking sector. It examines the banks balance sheet and behaviour and policies towards consumers. It also provides banks with services such as; i. Transfer of funds ii. Banks notes and coins iii. Foreign currency INDEPENDENCE OF CENTRAL BANK i.
Legal Independence: The independence of the Central Bank is enshrined in the law. It should be notated that in almost all cases, the Central Bank is accountable at some level to the government officials, either through the government minister or directly to Parliament. ii. Goal Independence: The Central Bank has the right to set its own policy goals, whether inflation targeting, control of the money supply, or maintaining a fixed exchange rate. This increases the increases credibility of the goals chosen by providing assurance that they will not be changed without notice. iii.
Operational Independence: The Central Bank has the independence to determine the best way of achieving its policy goals, including the type of instruments used and the timing of their use. iv. Management Independence: The Central Bank has the authority to run its own operation which include appointing staff, setting budgets etc. without excessive involvement of the government. CHALLENGES FACING CENTRAL BANKS i. Inflation ii. Control of interest rates iii. Supply of fake money iv. Foreign Exchange v. International Monetary Policy and Markets vi. Influence from the Government.