Central banks

1. CENTRAL BANKS
BANKING LAW
CLS 305

2. INTRODUCTION
• Central banks represent a country's financial institution but they
can also represent a group of them.
• The eurozone is an example of a financial institution made up of a
group of countries.
• In this case, the power falls under the Eurosystem, which is made
up of two fundamental parts: the European Central Bank (ECB) and
the national central banks of the eurozone's member states that
have the euro as their official currency-EAC 2015-2030?

3. INTRODUCTION
• The main function of a central bank is to act as governor
of the machinery of credit in order to secure stability of
prices.
• It regulates the volume of credit and currency, pumping in
more money when market is dry of cash, and pumping out
money when there is excess of credit.

4. ISSUE OF CURRENCY
• The central bank is given the sole monopoly of issuing currency in
order to secure control over volume of currency and credit.
• These notes and coins circulate throughout the country as legal
tender money.
• It has to keep a reserve in the form of gold and foreign securities
(dollars, Euros, Yen, Yuan and other convertible currencies) as per
statutory rules against the notes issued by it

5. ISSUE OF CURRENCY
• CBK issues all currency notes and coins in Kenya except the virtual
currencies such as Bitcoins, Samakicoins, etc.
• When the central government expenditure exceeds government revenue
and the government is unable to reduce its expenditure, then it borrows
from the CBK.
• This is done by selling security bills to CBK which creates new currency
notes for the purpose.
• This is called monetization of budget deficit or deficit financing.
• The government spends new currency and puts it into circulation to meet
its expenditure.

6. BANKER TO GOVERNMENT
• Central bank functions as a banker to the government—both
central and county governments.
• It carries out all banking business of the government.
• Government keeps their cash balances in the current account with
the central bank.
• Similarly, central bank accepts receipts and makes payment on
behalf of the governments.
• Also, central bank carries out exchange, remittance and other
banking operations on behalf of the government.

7. BANKER TO THE GOVERNMENT
• Central bank gives loans and advances to governments for
temporary periods, as and when necessary and it also manages
the public debt of the country.
• The central government can borrow any amount of money from
CBK by selling its shilling securities to the latter. Government
borrows temporarily from the-Central Bank in times of need.
These loans are called “ways and means advances”

8. BANKER TO THE GOVERNMENT
• Besides these, all other government loans, temporary (like
treasury bills) and permanent, are floated through the Central
Bank. In addition, it remits government funds, purchases foreign
currencies, as well as manages the public debt.
• It also acts as the financial adviser of the government. The CBK
performs all these functions for the Central and County
Governments in Kenya.

9. BANKERS’ BANK AND SUPERVISOR
• There are usually many banks in a country.
• There should be some agency to regulate and supervise their
proper functioning.
• This duty is discharged by the central bank. Central bank acts as
banker’s bank in three capacities: (i) It is the custodian of their
cash reserves.

10. BANKERS’ BANK AND SUPERVISOR
• Banks in a country are required to keep a certain percentage of
their deposits with the central bank; and in this way the central
bank is the ultimate holder of the cash reserves of commercial
banks.

11. BANKERS’ BANK AND SUPERVISOR
(ii) Central bank is lender of last resort.
• Whenever banks are short of funds, they can take loans from the
central bank and get their trade bills discounted.
• The central bank is a source of great strength to the banking
system,
• (iii) It acts as a bank of central clearance, settlements and
transfers.

12. CONTROLLER OF CREDIT AND MONEY SUPPLY
• Central bank controls credit and money supply through its
monetary policy which consists of two parts—currency and credit.
• Central bank has monopoly of issuing currency and thereby can
control the volume of currency.

13. CONTROLLER OF CREDIT AND MONEY SUPPLY
• Central bank controls credit and money supply through its
monetary policy which consists of two parts—currency and credit.
• Central bank has monopoly of issuing currency and thereby can
control the volume of currency.
• It can also determine interest rates

14. INSTRUMENTS OF MONEY POLICY
• (i) Bank Rate
• This is the rate of interest at which the central bank lends to
commercial banks.
• It is, in a way, cost of borrowing.
• Cheap credit promotes investment whereas dear money
discourages it. In a situation of excess demand and inflationary
pressure, central bank increases the bank rate.
• High bank rate forces the commercial banks to raise, in turn, the
rate of interest which makes credit dear.

15. (i) Bank Rate
• As a result, demand for loans and other purposes falls.
• Thus, increase in bank rate by the central bank adversely affects
credit creation by commercial banks. A decrease in bank rate will
have the opposite effect.
• Bank rate (also called repo rate, i.e. the rate at which banks
borrow from CBK) is currently 8.5-9%% and Reverse Repo Rate
(rate at which banks park their surplus funds with CBK) is about
7.0-8%.

16. INSTRUMENT OF MONETARY POLICY
• (ii) Open Market Operations
• These refer to buying and selling of government securities by
central bank to public and banks.
• This is done to influence money supply in the country.
• Sale of government securities to commercial banks means flow of
money into the central bank which reduces cash reserves.

17. (ii) Open Market Operations
• Consequently, credit availability of commercial banks is curtailed /
controlled.
• When central bank buys securities, it increases cash reserves of
the banks and their ability to give credit.

18. MONETARY POLICY
• (iii) Cash Reserve Ratio (CRR)
• Commercial banks are required under the law to keep a certain
percentage of their total deposits with the central bank in the form
of cash reserves.
• This is called CRR.
• It is a powerful instrument to control credit and lending capacity of
the banks.
• Presently, The CRR is currently set at 5.25 percent of the total of a
bank's domestic and foreign currency deposit liabilities.

19. (iii) Cash Reserve Ratio (CRR)
• To curtail the credit giving capacity of the banks, central bank
raises the CRR but when it wants to enhance the credit giving
powers of the bank, it reduces the CRR.
• Similarly, there is another measure called Legal Reserve Ratio—
LRR which has two components—CRR and Statutory Liquidity
Ratio (SLR).

20. (iii) Cash Reserve Ratio (CRR)
• According to Statutory Liquidity Ratio or SLR, every bank is
required to keep a fixed percentage (ratio) of its assets in cash
called liquidity ratio-ABOUT 25%.
• SLR is raised to reduce the ability of the banks to give credit.
• But SLR is reduced when the situation in the economy demands
expansion of credit.

21. EXCHANGE CONTROL
• Another duty of a central bank is to see that the external value of
currency is maintained.
• For instance, in Kenya, the Central Bank of Kenya takes steps to
ensure external value of a shilling.
• It adopts suitable measures to attain this object. The exchange
control system is one such measure.

22. EXCHANGE CONTROL
• A stable exchange rate is necessary to maintain and promote a
country’s foreign trade and to encourage the inflow of foreign
investments, which is so essential for accelerating the pace of
economic growth, particularly in the under-developed countries.

23. EXCHANGE CONTROL
• In order to maintain the rate of exchange stable, a Central Bank is
always prepared to buy and sell foreign currencies at the rates
fixed by it.
• However, when the cost-price situation in the country as also the
balance of payments position, undergo a substantial change, the
old rate of exchange may have to be changed.

24. LENDER OF LAST RESORT
• When commercial banks have exhausted all resources to
supplement their funds at times of liquidity crisis, they approach
central bank as a last resort.
• As lender of last resort, central bank guarantees solvency and
provides financial accommodation to commercial banks.

25. LENDER OF LAST RESORT
• The Central does this:
• (i) by rediscounting their eligible securities and bills of exchange
and (ii) by providing loans against their securities.
• This saves banks from possible failure and banking system from a
possible breakdown.
• On the other hand, central bank, by providing temporary financial
accommodation, saves the financial structure of the country from
collapse.

26. CUSTODIAN OF FOREIGN EXCHANGE OR BALANCES
• It has been mentioned above that a central bank is the custodian of
foreign exchange reserves and nation’s gold.
• It keeps a close watch on external value of its currency and undertakes
exchange management control.
• All the foreign currency received by the citizens has to be deposited
with the central bank; and if citizens want to make payment in foreign
currency, they have to apply to the central bank.
• Central bank also keeps gold and bullion reserves.

27. CLEARING HOUSE FUNCTION
• Banks receive cheques drawn on the other banks from their customers
which they have to realise from drawee banks.
• Similarly, cheques on a particular bank are drawn and passed into the
hands of other banks which have to realise them from the drawee
banks.
• Independent and separate realisation to each cheque would take a lot
of time and, therefore, central bank provides clearing facilities, i.e.,
facilities for banks to come together every day and set off their
chequing claim.

28. COLLECTION AND PUBLICATION OF DATA
• It has also been entrusted with the task of
collection and compilation of statistical information
relating to banking and other financial sectors of
the economy.

29. CBK
• The Central Bank of Kenya (CBK) was established in 1966 through an Act of
Parliament, the Central Bank of Kenya Act (1966).
• The formation of the Central Bank of Kenya arose from the desire amongst
the three East African states, Kenya, Uganda and Tanzania, to have
independent monetary and financial policies to drive their economies.
• This led to the formation of the three Central Banks in the region and the
eventual collapse of the East Africa Currency Board (EACB), which had been
playing this role from the 1920s until 1966.

30. CBK
• The current Kenya Constitution was promulgated in
August 2010.
• Article 231 (1) of the constitution entrenches the
Central Bank of Kenya in the constitution.

31. CBK
• Sub-article (2) of Article 231 of the constitution provides for the role of
the CBK thus: formulating monetary policy, promoting price stability,
issuing currency and performing other functions conferred on it by an
Act of Parliament.
• The constitution further provides, under Article 231 (3), that the CBK
shall not be under the direction or control of any person or authority in
the exercise of its powers or in the performance of its functions.

32. CBK
• The CBK is, in this case, granted autonomy by the
Constitution.
• The mandate and objects of the Central Bank of Kenya are
provided for under Sections 4 and 4A of the Central Bank
of Kenya (CBK) Act, which set out the Bank’s objects as
follows:

33. CBK MANDATE
i. To formulate and implement Monetary Policy directed to achieving and
maintaining stability in the general level of prices.
ii. To foster the liquidity, solvency and proper functioning of a stable market-
based financial system.
iii. To support the economic policy of the Government including its objectives for
growth and employment.

34. CBK MANDATE
i. To formulate and implement foreign exchange policy.
ii. To hold and manage foreign exchange reserves.
iii.To license and supervise authorized dealers.

35. CBK MANDATE
i. To formulate and implement such policies as best promote the
establishment, regulation and supervision of efficient and effective
payment, clearing and settlement systems.
ii. To act as banker and adviser to, and as fiscal agent of the Government.
iii.To issue currency notes and coins.

36. THE CENTRAL BANK’S MANDATE IS DISCHARGED
THROUGH SIX CORE FUNCTIONS
• Monetary Policy: The Central Bank collects and analyses
economic and financial data and undertakes research in
micro- and macro-economic activities to inform the
formulation of monetary policy geared towards achieving
and maintaining stability in the general level of prices.

37. THE CENTRAL BANK’S MANDATE IS DISCHARGED THROUGH
SIX CORE FUNCTIONS
• Financial Markets: To implement monetary policy decisions, the Central Bank
employs financial tools at its disposal to foster liquidity in the financial market
and manage growth of credit in the economy.
• The Bank manages the country’s foreign exchange reserves and intervenes to
mitigate unforeseen disruptions in order to ensure stability in the foreign
exchange market.
• Further, the Bank discharges its agency role to the National Treasury as it
manages the Government’s domestic borrowing.

38. THE CENTRAL BANK’S MANDATE IS DISCHARGED
THROUGH SIX CORE FUNCTIONS
• Bank Supervision: The Central Bank provides legal and regulatory
framework and issues prudential guidelines to govern the
operations of financial institutions under its mandate.
• It also licences and undertakes surveillance of the financial
institutions to ensure compliance with laws and regulations.

39. THE CENTRAL BANK’S MANDATE IS DISCHARGED THROUGH SIX CORE
FUNCTIONS
• Payment and Settlement Systems: Safe and efficient payment
and settlement systems is a key component of an effective and
efficient financial sector.
• The Bank formulates and implements such policies as best
promote the establishment, regulation and supervision of
efficient and effective payment, clearing and settlement systems
that promotes social and economic activities.

40. THE CENTRAL BANK’S MANDATE IS DISCHARGED
THROUGH SIX CORE FUNCTIONS
• Banking Services: The Central Bank provides banking services to
government ministries, departments and agencies, semi-
autonomous government institutions and county governments.

41. THE CENTRAL BANK’S MANDATE IS DISCHARGED
THROUGH SIX CORE FUNCTIONS
• Currency Services: The Central Bank is responsible for the design,
production and distribution of the Kenya currency. The Bank
ensures that there is adequate supply of clean currency to support
social-economic activities.

42. CONCLUSION
• A central bank is a public institution that is responsible for
implementing monetary policy, managing the currency of a
country, or group of countries, and controlling the money supply.

43. CONCLUSION
• Defining monetary policy – central banks set macroeconomic
objectives such as to ensure price stability and economic growth.
To do this, financial authorities have tools like setting official
interest rates, which have an impact on the cost of money. Based
on the economic situation, central banks will opt to either increase
official interest rates (to control inflation, for example) or decrease
them (to encourage consumption and boost economic growth).

44. CONCLUSION
• Regulating money in circulation – they are the authority for
issuing coins and notes, the money supply, and for regulating how
much money is in circulation. Central banks do this to inject
liquidity into the economy so that different economic agents
(families, companies and States) can use it in their transactions.
With regard to currencies, central banks are also responsible for
carrying out operations to ensure that exchange rates remain
stable, as well for owning and controlling their official reserves.

45. CONCLUSION
• Overseeing the inter-bank market – they ensure that the relevant
financial laws are respected and they monitor national payment
systems to make sure that they are working properly.

46. CONCLSUION
• Loaning liquidity to commercial banks if necessary for solvency
issues – aside from the loans made between institutions in the
inter-bank market, as mentioned in the previous bullet point,
commercial banks can also receive liquidity from central banks in
exchange for collateral, such as guaranteed public bonds. This
means that, if required, commercial banking institutions can cover
what they need in the short-term, while the central banks try and
ensure price stability by mediating in credit fluctuations.

47. CONCLUSION
• Taking on an advisory role – they regularly produce studies and
reports that are useful for governments or private organizations,
for example.

48. CONCLUSION
• Central banks do all of this independently of the political group in
power in any given country, as they aim to ensure the stability of
the financial system.
• Their decisions are directly dependent on the supervisory body
that composes the financial institution