How does the Central Bank exercise control over commercial banks?

Answer Details

The Central Bank (the Central Bank of Nigeria) supervises the banking system and controls the amount of credit that commercial banks create. It does this using the following instruments:

• Open market operations (OMO): the Central Bank sells government securities to reduce banks' cash and cut lending, or buys them to increase banks' cash and expand lending.
• Bank (discount) rate: by raising the rate at which it lends to banks as lender of last resort, it makes borrowing costly and discourages excessive lending; lowering it does the opposite.
• Cash reserve ratio: it fixes the minimum fraction of deposits banks must keep with it; raising the ratio reduces the funds banks can lend.
• Liquidity ratio: it stipulates the minimum proportion of liquid assets a bank must hold, limiting how much it can advance.
• Special deposits: it can require banks to lodge extra deposits with it, freezing part of their lendable funds.
• Selective credit control: it directs banks to lend more to priority sectors (e.g. agriculture) and less to others.
• Moral suasion: it appeals to and persuades banks to follow desired lending policies.
• Direct directives and regulation: it issues rules and guidelines and can penalise banks that breach them.