Free Custom «Functions of the Central Bank of Kenya» Essay Paper

Free Custom «Functions of the Central Bank of Kenya» Essay Paper

The Central Bank of Kenya was formed right after Kenya had gained its independence in 1903. The bank was formed as a national monetary authority intended to use a variety of monetary controls to enhance the efficiency of the monetary system. As a monetary authority, the bank performs various functions and roles that other commercial banks cannot perform. The roles of the bank keep on changing depending on the country’s economic conditions. The paper discusses the role of the central bank in Kenya and its reserve ratio compared to that of China, which is among the leading economies in the world. The following are some of the important economic roles that the bank plays.

Maintaining Price Stability. Proper maintenance of price stability is important because it ensures that the market-based economy functions properly (Government of Kenya, 2011).  Price stability is achieved when there is low or stable inflation that reduces price fluctuations in the market.  An economy achieves price stability once a price that no longer adversely affects the consumers and producers’ decisions is attained. The price of goods in the market and the rate of inflation in the economy depend on the amount of stock money in circulation. Therefore, the central bank plays the role of restricting the amount of money stock in the country. The bank achieves this objective by use of three important tools;

  • Open market operations, whereby the bank sells and buys treasury bills in the primary and secondary markets to achieve a desired level of bank reserves. When the bank buys treasury bills, it injects money into the economy, and when it sells - it drains or reduces the amount of money in the economy.
  • Reserve requirements, the central bank is a directive that requires commercial banks to deposit a minimum amount at the central bank as non-interest-bearing reserves. The increase in the bank reserve ratio serves to reduce the bank credit, and such reduction serves as a tool for credit creation.
  • Discount window operations. As a lender of last resort, the central bank grants temporary loans to commercial banks in need of funds but have already exhausted their market sources of funds.

Managing the Government Exchequer. The Central Bank of Kenya acts as e-bank of the government and is in charge of managing the Exchequer account of the treasury. The Exchequer account is where all the money collected as revenue is deposited before it is planned for and spent (Sichei, 2012).  The money in the Exchequer account is afterwards used to fund the projects that the government has planned to undertake in its various ministries.&nbs;  

It is the Banker’s Bank. Just as the commercial banks provide private individuals and consumers with banking services, the central bank also plays such a role but, in this case, to the commercial banks (Okiogo, 2013). Therefore, commercial banks rely on the Central Bank of Kenya for their banking services. Such banking services include the maintenance of clearing and settlement accounts for both the Kenyan domestic currency and foreign currency. The Central Bank of Kenya also plays the role of lending facility to the commercial banks.  Such loans are backed by the government securities, and they ensure that the commercial banks meet the minimum reserve requirement.

It Is a Supervisor to the Banking Industry. The Central Bank of Kenya is responsible for supervising the banking industry in the country. Therefore, it puts in place directives that guide the commercial banks and other financial institutions on how much money they should lend out to the public (Were & Wambua, 2014). The Central Bank also has the mandate to inspect and supervise the financial institutions and commercial banks to ensure that they follow the bank’s directives.

It Maintains the Reputation of the Kenyan Government. The Central Bank is responsible for ensuring the reputation of the Kenyan economy remains intact. The bank achieves this by taking account of the borrowings that the government has undertaken and ensuring that it complies with the payment procedure and directives. The bank also holds the official foreign exchange reserves of the economy to enable smooth repayment and servicing of the country’s external debt. The bank also intervenes in the interbank foreign exchange market so as to smooth out any errors that may affect the exchange rate of the Kenyan shilling.

It Issues Currency. The Central bank of Kenya has the sole responsibility of supplying the country with new coins and notes to replace the old unfit ones and meet the demand for the notes and coins (Sashoo, 2012). Sometimes, the Central Bank prints more currency to increase the money supply in the economy.  

Reserve Ratio. Reserve requirement is the minimum amount of money that the Central Bank requires all commercial banks in the country to hold. The Central Bank may require a commercial bank to increase the amount of the reserve if it wants to reduce the rate of inflation in the country. The reserve ratio may be reduced if the central bank wants to increase the amount of money in the economy.  Therefore, the reserve ratio is used as a tool of monetary policy especially in a deeveloping economy like Kenya (Were et al., 2014). By changing minimum reserve ratio, the Central Bank can influence the credit growth of the economy.

To determine the minimum reserve ratio, the Central Bank calculates the ratio as the proportion of the amount of money that is deposited by a customer. Then, the central bank determines how much the commercial bank should set aside rather than lending to the customers. Customer bank deposit takes many forms in commercial banks such as local or foreign currency. Therefore, the Central Bank often offers different types of ratio that require the commercial bank to deposit in local or domestic currency.  Below is the reserve ratio that is required by the commercial bank in Kenya compared to that of China, which is among the leading economies in the world.

In the year 2015, the reserve ratio in Kenya was 5.25%. While that of China was 18.50%. It means that the minimum reserve ratio that is required by the Central Bank of Kenya from all commercial banks in Kenya is 5.25%, which is almost four times lower than that of the People’s Bank of China requires from their commercial banks (18.50%).

For example, if a bank Q, in Kenya has local currency cash deposit of 1,000,000,000, the Central bank of Kenya may require bank Q to have a minimum reserve ratio of:

Local currency

5.25/100 x 1,000,000,000 = 52, 500,000

In the People’s Bank of China, the same local deposit by a commercial bank B of 1,000,000,000 would have the following reserve ratio.

18.5/100 x 1,000,000,000 = 185,000,000

During the same period, People’s Bank of China requires more money to be deposited by commercial banks than what is required by the Central Bank of Kenya. From the calculation, the commercial bank A from Kenya would have 947,500,000 million to lend to the customer after a deposit of one billion. On the other hand, the commercial bank B from China would have 815,000,000 million to lend to the customers after receiving a cash deposit of one billion.

To sum up, the Central Bank has many functions in the economy especially in developing nations such as Kenya. Among them is the supervision of the banks in Kenya. In this role, it puts directives that are supposed to be followed by the commercial banks. Another role is issuing of currency by disposing of old notes and printing new ones. Reserve ratio is another function of this bank. Reserve ratio is the amount of money that the commercial banks are supposed to deposit with the central bank.

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