A central bank, reserve bank, or monetary authority is an institution that manages a state's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the amount of money in the nation, and usually also prints the national currency, which usually serves as the nation's legal tender. Examples include the European Central Bank (ECB) and the Federal Reserve of the United States.
The primary function of a central bank is to manage the nation's money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as a lender of last resort to the banking sector during times of bank insolvency or financial crisis. Central banks usually also have supervisory powers, intended to prevent bank runs and to reduce the risk that commercial banks and other financial institutions engage in reckless or fraudulent behavior. Central banks in most developed nations are institutionally designed to be independent from political interference. Still, limited control by the executive and legislative bodies usually exists.
Functions of Central Bank
1. Bank of Note Issue:
The central bank has the sole monopoly of note issue in almost every country. The currency notes printed and issued by the central bank become unlimited legal tender throughout the country.
In the words of De Kock, "The privilege of note-issue was almost everywhere associated with the origin and development of central banks."
However, the monopoly of central bank to issue the currency notes may be partial in certain countries. For example, in India, one rupee notes are issued by the Ministry of Finance and all other notes are issued by the Reserve Bank of India.
The main advantages of giving the monopoly right of note issue to the central bank are given below:
(i) It brings uniformity in the monetary system of note issue and note circulation.
(ii) The central bank can exercise better control over the money supply in the country. It increases public confidence in the monetary system of the country.
(iii) Monetary management of the paper currency becomes easier. Being the supreme bank of the country, the central bank has full information about the monetary requirements of the economy and, therefore, can change the quantity of currency accordingly.
(iv) It enables the central bank to exercise control over the creation of credit by the commercial banks.
(v) The central bank also earns profit from the issue of paper currency.
(vi) Granting of monopoly right of note issue to the central bank avoids the political interference in the matter of note issue.
2. Banker, Agent and Adviser to the Government:
The central bank functions as a banker, agent and financial adviser to the government,
(a) As a banker to government, the central bank performs the same functions for the government as a commercial bank performs for its customers. It maintains the accounts of the central as well as state government; it receives deposits from government; it makes short-term advances to the government; it collects cheques and drafts deposited in the government account; it provides foreign exchange resources to the government for repaying external debt or purchasing foreign goods or making other payments,
(b) As an Agent to the government, the central bank collects taxes and other payments on behalf of the government. It raises loans from the public and thus manages public debt. It also represents the government in the international financial institutions and conferences,
(c) As a financial adviser to the lent, the central bank gives advise to the government on economic, monetary, financial and fiscal matters such as deficit financing, devaluation, trade policy, foreign exchange policy, etc.
3. Bankers' Bank:
The central bank acts as the bankers' bank in three capacities:
(a) Custodian of the cash preserves of the commercial banks;
(b) As the lender of the last resort; and (c) as clearing agent. In this way, the central bank acts as a friend, philosopher and guide to the commercial banks
As a custodian of the cash reserves of the commercial banks the central bank maintains the cash reserves of the commercial banks. Every commercial bank has to keep a certain percentage of its cash balances as deposits with the central banks. These cash reserves can be utilised by the commercial banks in times of emergency.
The centralization of cash reserves in the central bank has the following advantages:
(i) Centralized cash reserves inspire confidence of the public in the banking system of the country.
(ii) Centralized cash reserves provide the basis of a larger and more elastic credit structure than if these amounts were scattered among the individual banks.
(iii) Centralized reserves can be used to the fullest possible extent and in the most effective manner during the periods of seasonal strains and financial emergencies.
(iv) Centralized reserves enable the central bank to provide financial accommodation to the commercial banks which are in temporary difficulties. In fact the central bank functions as the lender of the last resort on the basis of the centralized cash reserves.
(v) The system of centralized cash reserves enables the central bank to influence the creation of credit by the commercial banks by increasing or decreasing the cash reserves through the technique of variable cash-reserve ratio.
(vi) The cash reserves with the central bank can be used to promote national welfare.
4. Lender of Last Resort:
As the supreme bank of the country and the bankers' bank, the central bank acts as the lender of the last resort. In other words, in case the commercial banks are not able to meet their financial requirements from other sources, they can, as a last resort, approach the central bank for financial accommodation. The central bank provides financial accommodation to the commercial banks by rediscounting their eligible securities and exchange bills.
The main advantages of the central bank's functioning as the lender of the last resort are :
(i) It increases the elasticity and liquidity of the whole credit structure of the economy.
(ii) It enables the commercial banks to carry on their activities even with their limited cash reserves.
(iii) It provides financial help to the commercial banks in times of emergency.
(iv) It enables the central bank to exercise its control over banking system of the country.
5. Clearing Agent:
As the custodian of the cash reserves of the commercial banks, the central bank acts as the clearing house for these banks. Since all banks have their accounts with the central bank, the central bank can easily settle the claims of various banks against each other with least use of cash. The clearing house function of the central bank has the following advantages:
(i) It economies the use of cash by banks while settling their claims and counter-claims.
(i) It reduces the withdrawals of cash and these enable the commercial banks to create credit on a large scale.
(ii) It keeps the central bank fully informed about the liquidity position of the commercial banks.
My advise to a petty trader that intends to get loan from CENTARL BANK.
As I mentioned above functions for CENTRAL BANK, they don’t give loan to petty traders but to Banks.
So my advice to the petty trader is to go Commercial Banks or Microfinance Banks for loan by these moves:Microfinance banks are financial institutions that provide small loans to individuals or groups. They also give entrepreneurs and organizations, access to credit facilities for their businesses. They grant loans to individuals and small scale enterprises (SMEs) to be paid back in small installments with a little interest.
The roles of micro-finance banks in the development and growth of a country’s economy cannot be overemphasized. They play key roles in poverty alleviation, agricultural development, increase in small scale businesses and so on. Here, we will be focusing on microfinance banks in Nigeria and how they grant loans.
If you are a business man or woman, a petty trader or an individual in need of financial assistance, micro-finance banks have a primary objective of giving credit facilities to applicants who fall into this category.
The following are simple steps to getting a loan from most microfinance banks in Nigeria.
Having a Genuine Reason Or Project For The LoanMicrofinance banks will never loan you money for frivolities. If you want to get a loan from a microfinance bank, you must have a genuine reason for it. It could be for business purpose or personal development, so long as your purpose for applying for the loan is important.
Microfinance banks only grant loans that fall into the category of small and medium enterprises (SMEs). They are also into businesss, and no business wants to run into loss. Granting loans is a serious business. Therefore, whatever you need credit facility for, must be serious business or an important project, with a guaranty that you will repay your debt.
The kind of credit facility that most microfinance banks grant are loans for business purposes, asset procurement, agriculture, educational purposes and loans for salary earners. No microfinance bank will give you loan if there is no moneyback guaranty.
Document ItYou can further facilitate access to loan from a microfinance bank by presenting a document in respect of your reason for applying for that loan. It could be in form of a document concerning a project you are working on, for which you need financial assistance.
For instance, if you are a contractor needing financial assistance to complete a project for which you have been paid in part, in which you will not be given the balance of your payment until the project is completed. All you need to do is present the proposal for the contract, acceptance of your proposal, payment agreement and all other relevant document. This will stand as a proof that your purpose for applying for the loan is genuine. It will also serve as a reference.
Open An Account With The BankThe first thing you will be asked to do when you go to apply for a loan in a microfinance bank is to open an account with the bank. This is to show that you are serious and you are willing to be committed to the bank.
Service The Account For A Period Of TimeIt doesn’t just stop at you opening an account with the micro-finance bank, you need to actively service the account i.e paying and withdrawing money from the account constantly, before you can be qualified to apply for a loan.
This will help them to build trust in you. It will also assure the bank that you will repay the loan if it is granted.
Present A Collateral Or Its DocumentsYou also need to present a collateral when applying for a loan in a microfinance bank. This may not apply to small business loans for petty traders and individuals. In fact, some microfinance banks do not require collateral e.g Lift Above Poverty Level (LAPO). But, it will be necessary for business loans that fall into the category of assets acquisition, agriculture and other loans of a larger amount.
Your collateral must equate the amount of loan you are applying for or supersede it, but it cannot be lesser in money value to the loaned amount.
10 Tips You Must Know When You Seek For A Bank Loan In Nigeria
Every business at some point in its operating cycle will require some form of finance to pay its short term indebtedness or to fund new projects or business plans, or to acquire operating assets. Individuals at some point in their life may also need bank loans to help fund the purchase of a car, mortgage for a house or buy house hold appliances.
1. You need to formally apply to a bank for a loan – When most people think of approaching a bank for a loan, they commonly ask for a business plan. However, not all businesses require a business plan. But all loans must require that you apply to the bank formally as such it is important that you are able to articulate your needs in your application letter.
2. Banks charge interest on a per annum basis and they are not fixed- Banks do not charge interest rates per month but per annum. What this means is that when a bank offer a 20% interest on a loan it is per annum and not per month. For example, when you apply for a loan of N1million for a 3 month tenor at an interest rate of 20%, your interest will be N50,000. Which is 20% of N1million apportioned for just 3 months out of the 12. However, it can actually be lower depending on how often you repay the principal. Meaning if you repay N300,000 at the end of the first and second month and N400,000 for the third month your interest will be 20% of N1m for the first month =N16,667. Second month will be 20% on N700k for one month= N11,667 and finally N20% on N400k for one month = N6,667. The total is now N35k. The interest rates offered to you is also not cast in stone as banks often have a caveat in the offer letter that allows them to increase the rate whenever they feel the market conditions require it.
3. Different banks offer different interest rates and terms and conditions – Just the way the price of goods and services differ in the market so does the interest rates and terms and condition banks offer. Whilst some might favour you in terms of lower interest rates they might offer shorter repayment period. This takes me to the next point;
4. Never ignore the terms and conditions – When gives you an offer letter they always include a set of “Other Terms and Conditions” or “OTC”. Usually, they differ from the conditions like collateral, interest rate, tenor (Terms and Conditions or TC) that most people prefer to look at. The issue however, is that when a loan goes bad and a bank takes you to court it is not the TC that often matter. The OTC is probably more important as it typically contains those issues that determine what the bank can do in the event of a default.
5. Banks always ask for a collateral or some form of security – Banks no matter the type of loan you ask for will ask for some form of collateral. It could be a landed property, asset or even your personal guarantee. Sometimes they remember to register claim to these collateral in the court and sometimes they don’t. When they don’t they are at risk to loosing claim to the asset in times of default. But don’t be fooled the court may still recognize an encumbrance even if it isn’t registered.
6. Defaulting on repaying your bank loans when their due doesn’t mean the bank will take over your business – Yes, banks like to avoid the court as much as you do and quite frankly want you to succeed because your success and theirs is directly proportional. If you can’t pay back all of your loans, it is better to pay a portion of it that you are able to than not pay at all. Judges often take cognizance of that which positively helps your case. So when you default in repaying any portion of your loans endeavor to approach the bank and seek a new deal.
7. You can always attempt to refinance or restructure your loan - Following from above, you can always approach your bank to restructure your loans if you think the current terms are not favorable to you. And it is not also when your loan is bad that you can approach a bank. You can also approach them when your business is doing well and your are servicing your loans promptly. Business are such that the owners must constantly seek ways to improve its operational conditions you cannot just rest on your oars. Refinancing your loan involves approaching another bank to take over your existing loan as a new lender. You should utilize this option when the new bank offers your better T&C.
8. You can ask your bank for a moratorium - A moratorium is simply a bank permission to a borrower to suspend repayment of principal for a period of time. Because some business ideas require time to start making money despite borrowing from a bank, it makes sense to give the business some time and not burden it with huge cash outflows that it could better use in growing the business. Banks recognize that and will often allow borrowers a period of grace (one month, three months, one year etc) where they only pay interest and resume paying interest and principal at the end of the moratorium.
9. The biggest threat to defaulting is not your interest rate but your Debt Service Coverage Ratio (DSCR)- Imagine two guys Mr A and B each borrow N1million but with Mr A told to repay over one year and Mr B over N3 years.They both get charged 20% per annum interest rates and will repay principal and interest at equal installments. Mr A will have to pay a total of N92k every month for one year till the loan is repaid whilst Mr B pays N37.1k every month for the next three years. Now assuming they both generate cash of N100,000 every month in their business who do you think will go default sooner should there be a sudden drop in revenue within the first year? Certainly it is Mr A, even though he pays less interest (total of N111.6k) compared to Mr B (N337.8k) over three years. This is because Mr A has a DSCR of 1.09x compared to Mr B with 2.7X. Provided Mr B’s business earns a return on his investments that is over 20% he almost sure to make a profit despite paying higher interests.
10. Banks have hidden charges – Apart from the interest rate bank charge, they also charge you fees and C.O.T. But off course we are familiar with these. However, banks also have other cost which they mostly do not tell you when you apply for a loan. For example, they deduct taxes whenever they charge you C.O.T or WHT when they are paying you an interest. They also charge you punitive interest rates whenever you default in payments even though your loan agreement provides a less punitive rates for such. It is important to always ask your accountant to conduct a monthly spot check on charges when they prepare bank reconciliation reports.
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