Central Bank Policy Decisions

Question: Discuss about the Central Bank Policy Decisions. Answer: Effect of Central Bank Policy Decisions on Profitability of Banks The banking sector needs to adjust to the changing market in the bank industry and environment just like any other economic sector. The central bank has the powers and obligation of controlling and regulating the activities of the banks and other financial institutions by making policy decisions which the banks should adhere to. There are different emerging issues in the bank industry which needs to be examined in the control of the industry by making policy decisions that affects banks. Some of the issues needs to be addressed include policy decisions on the rate of interest rates, inflation, the monetary policy, regulatory environment which greatly affect the profitability of these banks in the industry. The major part of the revenues of the banks and the central banks come from different bank operations which are affected by the changes in interest rate (Atieno,2006). The central banks make decisions concerning the policy guiding the banks in their industry. Central bank decisions on monetary policy affect the profitability of the banks by improving the investments. The monetary decision by central bank can be accommodative or unbiased. The central banks make decisions on the increase of short term interest rate when inflation is increasing and lowering of the short term interest rate when the economy is lagging. The decisions made follows the following monetary policy tools which includes, federal reserve which entails open market operations the purchase and sale of financial instrument, the use of discount charged on the institutions depositing amounts in the central bank and lastly amount the banks can maintain as reserve with the central bank. These monetary policy tools help in the control of amount of money in supply in the economy.The control of supply of money helps reduce inflation, control interest rate and hence leads to increased profi tability of the banks with effective bank services and reduction of inflation which involves price changes and interest rate which the banks depends on for profitability (De Aghion,2003.) Central banks in collaboration with the Bankers Association in different countries have rolled out policies and regulations that have helped in the operation of the financial institutions. One of the policy decisions they have made include allowing the banks to share information on credit lending. Based on the central bank policy decision on sharing of information, banks are able to share credit information on their customers. This has facilitated better assessment of the risks associated with borrowers of credit. The sharing of credit information allows credit institutions like banks to extend credit to customers through the internet without using physical collateral. It is from the Central Banks policy decision of sharing of credit information that has translated to lower cost of credit and helped increase uptake of loans by financial institutions clients. The uptake of credit by the customers has led to the increase in profits brought about by increase in interest rate charged on the loans given ( Bell,2011). The central bank has the obligation of setting the monetary policy goals. It makes policy decisions that help to improved growth and to promote price stability. Decisions made by the central bank like Mexico in the past have helped restructure their monetary policy objectives like maintaining price to be stable as the main goal of the central bank. Any central bank makes monetary policy decisions on setting of objectives that the price determination process can be attained by curbing inflation levels leading to low inflation targets leading to improved performance leading to profitability. The central bank has also come up with decision which permits banks to use third parties (Agent Banking) to provide financial services on their behalf. Subsequently, central bank has reviewed and made policy guidelines on Agent Banking. The policy allows credit institutions to search for central bank support for the approval of specific agents to conduct the work and define the type of work they will provide. It is the duty of the financial institutions to examine the suitability of the agents in line with the policy decision. This policy decision has helped to straighten the lending of credit to customers and improved bank services which are made efficient leading to profitability of the banks in the industry. Based on the policy and regulatory framework of the central bank, the legal environment is firm to banks and financial institutions. According to the World Bank, most of the central banks in different countries are lagging in the development of policies and legislations. Consequently, the central bank has made policy decisions for banks to conduct their operations fairly without any unfair competition in preventing customers from accessing the banks services. Medium and long term interest rates depend on other factors like the expectation of the short term interest rates .The central bank has made different policy decisions to induce changes in the short term interest rates which affects the entire interest rate which increases the cost of credit ,leading to low lending of credit leading to reduced investment and low profitability. The central bank has also made a policy decision which allows financial institution clients to be treated like those of other financial institutions like Saccos and microfinances in the case of security of the loan and means of recovery of the loan borrowed. The central bank decision through the Act of parliament set the rules on the lending of credit hence leading to control of the activities of the bank. The effective credit management leads to credibility of the bank eventually leading to improved performance leading to profitability of banks. After the recession of 2008, many financial institutions like banks have been affected, as the credibility of the banking system has been compromised. Towards the end of 2015, worlds economy started to recover more strongly and this positive momentum was sustained into the year 2014 where world currencies deteriorated due to high rate of inflation. The different central banks came in rescue with policy decisions that were attributable to increased credit to the private sector and low inflationary pressure. The pro-active central bank policies decisions have also led to developments in the economy. More investors have come into the country to invest and hence improving the economy of the country.The financial sector recorded its highest growth for the last decade growing at 3 per cent in 2013 compared to 5.4 percent in 2017. The growth is due to increase borrowing riding on financial innovation that has enhanced access to financial services and uptake of loans.Most financial instituti ons like banks are setting short loan settlement periods, high interest rates and short grace periods not only to meet the working costs and protect themselves from (collateral) concerned in lending to customers. The central bank has made decisions that have helped in regulating the amount of money in circulation by ensuring each bank keeps a saving account with the central bank. This will ensure that the operations of the banks in lending capital are controlled (Elbanna,2007). The management of financial institutions should demonstrate their understanding and commitment in making compliance to rules and regulation as one of their strategic objectives and to opt for best practices in MIS (management information system) to improve their profitability. The banks should adhere to the policy decisions made by the central bank. References Atieno, R. (2006).Institutional credit lending policies and the efficiency of resource use among small scale farmers in Kenya. Boulder: Westview Press. Aryeetey, E. Urdry, C. (2007).The characteristics of informal financial markets in Sub-Saharan Africa.Journal of African Economies.Vol. 6, No 3 pp.12-34. Bell, C. (2011). Interactions between institutional and informal credit agencies in rural India. World Bank Economic Review, Vol.4, No 3 pp. 234-45.. De Aghion, A. and Morduch, J. (2003) Microfinance: Where Do We Stand? inFinancial Development and Economic Growth: Explaining the Links, ed. by C. Goodhart, Bsingstoke: Macmillan/Palgrave). Denscombe, M. (2009).The Good Research guide: For Small-Scale Research Projects.Philadelphia: U.S.A, Open University Press. Elbanna, S. (2007). Influences on strategic decision effectiveness: Development andtest of an integrative model. Strategic Management Journal Vol. 28(4): 431.