Written by As the apex bank of Nigeria, the Central Bank of Nigeria is charged with the responsibility of managing the supply of money in Nigeria.
In fact, the conduct of monetary policy is one of the core mandates of the Central Bank of Nigeria.
The legal authority to conduct monetary policy by the CBN is derived from its Act of 1958 as amended in 1991 and 2007 Acts.
In order to fulfil this mandate, the CBN makes use of various instruments of monetary control.
These instruments are Open Market Operations, bank rates, Reserve requirements, Stabilization securities, Moral suasion, and Credit ceiling.
Through these instruments, the Central Bank of Nigeria is able to effectively manage the supply of money in Nigeria and ensure the stability of the Nigerian economy.
Open market Operations
The Central Bank buys or sells government securities in the money market on behalf of the Federal government of Nigeria.
If the CBN thinks that there is too much money in circulation, it will sell government securities like treasury bills to commercial banks and the public.
In exchange, the Central Bank receives cash, which reduces the lending capacity of banks and the amount of money available in the economy.
On the other hand, if the Central Bank feels that there is a need to inject funds in the economy, it will buy government securities, like treasury bills, from commercial banks and the public.
This puts more money into circulation in the economy and allow banks to have more funds to lend to the general public.
Thus, the CBN expands or contract the money supply through purchase or sale of government securities like treasury bills.
Reserve Requirements
Reserve requirement for commercial banks is by far the most effective tools employed by the Central Bank of Nigeria to control credit and money supply.
By law, all commercial banks operating in Nigeria are required to keep a portion of their deposits in a special account with the Central Bank.
This serves as a safety net, in case any of the banks experience financial difficulties.
If the Central Bank observes that banks are creating too many credits, it may raise the cash reserve ratio to a higher percentage, which will naturally reduce the capacity of the commercial banks to create credit.
Conversely, if the Central Bank wants to increase the amount of credit that are created by banks, then it may reduce the cash reserve ratio.
The result is that the capacity of the commercial banks to create credit will increase and expansion of credit in the economy takes place.
Bank rate
The Central Bank lends to financially sound commercial Banks at an interest rate, called Bank rate.
Bank rate is the official interest rate at which the Central Bank of Nigeria allows the Commercial Banks to borrow short term in order to meet liquidity position, reserve requirements or loan demand.
If the CBN raises the bank rate, it becomes more expensive for commercial banks to borrow money from the CBN, which may cause commercial banks to increase their lending rates to the public.
This, in turn, makes borrowing money more expensive for the public, and reduce the amount of money in circulation.
On the other hand, If the CBN lowers the bank rate, it becomes cheaper for commercial banks to borrow money from the CBN, which can cause commercial banks to lower their lending rates to the public.
The result is that borrowing money becomes more affordable for the public, and the amount of money in circulation increases.
So, during periods of inflation when the Central Bank of Nigeria want to reduce the money supply, it achieves it by raising the bank rate, and, during periods of recession, when the central Bank of Nigeria want to increase the money supply, it will decrease reduce the bank rate.
Stabilization Securities
Stabilization securities are one of the major money market instruments that the central bank of Nigeria used for mopping up excess liquidity in the banking system.
When there is excess liquidity in the banking system, the CBN usually issue stabilization securities to banks and other financial institutions to absorb the excess liquidity.
When this happens, the amount of money available to banks will decrease, so that the lending capacity of banks and money supply decreases.
Credit Ceiling
Sometimes, the Central Bank of Nigeria places limitations on the amounts of credits that bank may extend during a particular period.
This is called credit ceiling and it serves as an effective way for the CBN to control credit creation in Nigeria.
When the CBN sets a credit ceiling, it specifies the maximum amount of credit that banks can provide to their customers for a particular period.
If banks exceed this limit, they may face penalties or other consequences.
The central bank usually used credit ceiling as an means of controlling creation capacity of banks.
For instance, if the CBN notices that banks are creating too much credit, which could lead to inflation, it may decide to lower the credit ceiling.
This would force banks to limit the numbers of credits they provide, which would reduce the amount of money circulating in the economy.
Similarly, if the Central Bank of Nigeria wants to increase the amount of money in circulation, it may raise the credit ceiling.
This would allow banks to provide more credit to borrowers, thus increasing the money supply in the economy.
Moral Suasion
Since the Central Bank of Nigeria issues licenses to Banks and regulate their activities, it can, from this advantage, persuade banks to follow a particular path.
This is called moral suasion. To define it, moral suasion is a persuasive method of money control used by the CBN to encourage banks to take certain actions that are in line with the CBN’s objectives.
Moral suasion involves the Central Bank using influence to persuade banks to take certain actions voluntarily, without necessarily enforcing any legal or regulatory actions.
For example, the Central Bank can persuade banks to take certain actions, such as restricting credits, increase financial support to exporters, increase saving mobilization, which otherwise they would not do on the basis of risk/return assessment.
The goal of moral suasion is to encourage banks to take certain actions in line with the CBN objectives, without necessarily enforcing any legal or regulatory actions.
