The central bank

Business studies study module

This is a bank established by the government through the act of the parliament to manage and control the monetary matters in the country. It was formed to perform the following functions;

  • Issue currency in the country, which includes both new notes and coins to replace the worn-out ones
  • Banker to the commercial banks, by ensuring that all the commercial banks in the country operate an account with them
  • Being the government ‘s bank, by offering banking services to the government which enables the government to operate an account with them
  • Advisor to the government on financial issues in the economy
  • Controller of the commercial banks on how they carry out their functions in the economy to ensure that their customers are served well
  • Provide links with other central banks in other countries, facilitating financial relationships. It also provide a link between the country and other financial institutions such as IMF
  • Maintain stability in the exchange rates between the local currencies and the foreign ones.
  • Act as the lender of the last resort to the commercial banks to enable them meet their financial obligations when need arise
  • Facilitates the clearing of cheques between different commercial banks through its clearing house (a department in the central bank)
  • Administering of the public debt by facilitating the receipt and providing a means through which the government pays back the borrowed money
  • Control of the monetary system in the country in order to regulate the economy. In doing this they put in place various monetary policies that can either expand the economic activities in the country or depress them.

Monetary policy refers to the deliberate move by the government through the central bank to manipulate the supply and cost of money in the economy in order to achieve a desirable economic outcome. They do this through the use of various tools of monetary policies which includes the following: Bank rates; Open market Operation (OMO); Cash Liquidity ratio requirement; Compulsory deposit requirement; Selective credit control; Directives; Request.

  • Bank rates

They may increase or decrease the interest rate at which they lend to the commercial banks to enable them increase or decrease the rate at which they lend money to their customers in the economy to enable the government achieve the desirable economic development in the country

When they increase their lending interest rate, the commercial banks also raise their lending rates to the consumers to reduce the number of people obtaining loans, leading to a reduction of money supplied in the economy.

When they decrease their lending interest rate, the commercial banks also decreases their lending rates to the consumers, increase the amount of money supplied in the economy

  • Open Market Operations (OMO)

This is where they regulate the supply of money in the economy by either selling or buying the government securities (treasury bills or bonds) in the open market. That is when they want to increase the supply in the economy, they buying the securities from the members of the public who had bought them to increase more supply of money in the economy.

When they want to reduce the amount of money in circulation they will sell the government security to the public in the open market, to mop up/reduce the excess supply in the economy

The payment of the securities takes money from the individuals accounts in the commercial banks, reducing the amount that the individual can use in the economy, while when buying the central bank pays the security holders in their respective accounts in the commercial banks, increasing the amount that they can use in the economy

  • Cash/liquidity ratio requirement

Here the central bank expect the commercial bank to keep a certain proportion of their total deposits in form of cash to enable them meet their daily needs, while the rest are held in liquid assets. This proportion can be reduced by the central bank to reduces the amount of money held by the commercial banks in order to reduce the amount of money spent by the commercial banks in cash, reducing the amount of money in supply, or they may increase the proportion to be held by the commercial banks to enable them increase the amount of money they spent in cash, increasing the amount of money in supply

Cash ratio =

  • Compulsory deposit requirements

The commercial banks are required to maintain a certain amount of deposits with the central bank which will be held in a special account where the money stays frozen. This reduces the amount of money that the commercial banks hold and are able to spend in their operation, influencing the supply of money in the economy.

The deposit may be increase to reduce the amount of money in the commercial banks, or reduced to increase the amount of money in the commercial banks

  • Selective credit control

The central bank may issue a special instruction to the commercial bank and other financial institution only to lend more in a particular sector to control the amount of money reaching the economy. The instruction may be removed, if the bank feels that the supply in the economy has reduced and needs to be increased

  • Directives

The central bank may issue a directive to the commercial banks on the interest rate they should charge on their lending and to increase or reduce the margin requirement for borrowing to make it harder or easier for the customers to obtain loan.

Margin requirement is the proportion of money expected to be raised by the client to finance the project he/she wants to obtain the loan for, before being given a loan to complete the project with.

  • Request (Moral suasion)

The central bank may appeal to other financial institutions to exercise restrain in their lending activities to the public to help in controlling the money supply

Trends in Banking

These are the positive changes that have taken place in the banking sector to improve their service deliveries to their customers. They include;

  1. The use of Automatic Teller Machines (ATMs), which has made it possible for the customers to access their money any time of the day. The ATM cards that are used for withdrawals from the ATM machines can also be used as a debit card to make purchases.
  2. Networking all their branches, which has enable the customers to carry out their transactions in any of the branch.
  3. E-Banking, which is the banking through the internet. This has made it possible for the customers to transact their financial businesses on-line.
  4. Relaxation of some of the conditions on opening and operating some of the accounts to make them be more attractive to their customers.
  5. Offering varieties of products which includes easier credit facilities to their customers to attract more customers.
  6. Liberalization of foreign exchange dealings by licensing forex bureaus to offer services to the customers, improving the accessibility to the service.
  7. Improving the customers care services, with some bank setting up a departments known as the customer care department to offer detailed assistance to their customers.
  8. Allowing non bank financial institutions to offer banking services to the members of the public, for example; KWFT, SACCOs, FOSA, Faulu Kenya, etc
  9. Mobile Banking services (M-Banking), which allows the customers to carry out their financial transactions over their mobile phones. It has brought about several benefits/ advantages to their customers which includes;

Advantages of m-banking

  • Easy transfer of funds from one account to the other in the same bank (inter account transfer)
  • Easy transfer of money from ones account to his mobile phone for other transactions
  • Ability to check ones account balance in the bank with ease
  • Easy to monitor your financial transactions by checking your transaction details over the phone
  • Easy payment of the bills such as electricity bill, Dstv bills, etc and other wages
  • Ability to transfer money from one mobile number to other in collaboration with the service providers
  • Easy request for new cheque books and bank statements from the banks
  • Able to top up air time to your mobile phones in collaboration with the service providers
  • Reduced risk of carrying large sums of money in cash or cheques that may be stolen

However this development has also come with its challenges, which includes:


Disadvantages of m-banking

  • Registration to enjoy all these services must physically be done in the banking hall, which subject the customers to stress queues of the bank
  • Only the registered mobile number can carryout these transactions which limits the customer to only using one number
  • Users requires a mobile phone with a screen that can display the transaction which a times some may not a ford
  • Mobile phones can easily be lost or stolen from the owner, inconveniencing him from carrying out the transactions
  • Bank transaction information may load slowly, which may makes it expensive for the user
  • Possibility of transferring the funds to a wrong account, due to error in typing of the account number
  • Introduction of agency banking, which has made them to make their services to be more accessible to even areas where they may have not put up a banking hall.

Agency banking is whereby a retail stores, supermarket, or any other commercial businesses are authorized by the financial institutions to carry out financial transactions on their behalf. They may offer the following services

  • Receiving customer deposits
  • Offering withdrawal services
  • Transfer of funds for customers
  • Pay bills for the customers
  • Balance inquiry services
  • Opening new accounts for the customers
  • Fill loan application forms for them

Advantages of agency banking

  • Reduction of set up and delivery cost to the banks, which in turn passes to the customers in form of reduced cost of accessing services
  • Time saving as the agents are located close to the customer and the customer may carry out other transactions as he withdraw the money
  • More convenient for the customer to bank with their local retailers other than the traditional banking halls
  • Enable the bank to reach far places within the country



  1. Give four advantages of barter trade.
  2. Highlight four services offered by the central bank of Kenya to the commercial banks.
  3. State four methods through which commercial banks can transfer money.
  4. State any four current developments that have taken place in the banking sector.
  5. Outline four tools of monetary policy used by the central bank to control money supply.
  6. Outline four factors that may have led to the downfall of barter trade.
  7. Highlight two factors that may influence:
  8. Transaction motive.
  9. Speculative motive.
  10. Mention four functions of commercial banks in an economy.
  11. Outline three factors that influence the supply of money.
  12. Give four characteristics of money.
  13. The following are some of the accounts available to customers in Kenya banking industry: Current account, Savings account and Fixed deposit account. Give the account that corresponds to each of the description given below.
  14.   Description Type of account
    (a) Account holders required to deposit a specific initial amount as well as maintaining a minimum balance.  
    (b) Account holders may deposit and withdraw money whenever they want without maintaining a minimum balance.  
    (c) Banks pay interest on deposit at comparatively higher rates.  
    (d) Money may be deposited at any time and interest is earned if a specific balance is maintained.  
  1. Outline four benefits that accrue to a customer who uses automated teller machine (ATM) banking services.

PAPER       2

  1. Explain five functions of the central bank of Kenya.
  2. Describe four measures that the government may put in place to reduce the amount of money in circulation.
  3. Explain five services offered by commercial banks to their customers.
  4. Explain five ways in which commercial banks facilitate payment on behalf of their customers.
  5. Explain four services that the central bank of Kenya may offer as a banker to commercial banks.
  6. Explain five in which banks contribute to the development of Kenya
  7. Outline five reasons why banks currently account is popular with traders
  8. Explain service offered to commercial banks by the central bank of Kenya
  9. In what ways of the functions of commercial bank differ with those of non- bank

Financial institutions

  1. Explain five ways in which central bank of Kenya may control the supply of money in

The country

  1. Describe methods which may be used by commercial banks to advance money to customers.
  2. A businessman wishes to obtain a loan from a commercial bank. Highlight the

Conditions that he should satisfy before the bank can grant him the loan

  1. Explain five services that the central bank of Kenya offers to commercial banks     Explain four disadvantages of using a  bank  overdraft as a  source of finances
  2. Describe four ways in which a non- bank financial institutions differ from the  commercial banks
  3. Discuss five reasons why business people prefer to operate bank current accounts

Outline the benefits that bank  customer gets from  operating a current  account Explain the 5 services  offered by a  commercial banks to their customers

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