By: Dr. Mohamed O Nur-Shacabi, Sr. Business Development Consultant

The next step of Somaliland Monetary System needs is to set up a Central Bank by asking the European Countries and United Arab Emirates to find a way to utilize a banking system that could meet the regulation and circulation need for an expanding supply of money yet at the same time control it so as to avoid the crises to which it was prone and the unsettled money transfers of the recent existing Hawala or money transfer companies.

The institution which partially accomplished this is the central bank. The Central Bank in Somaliland can create currency when it buys from the government or other assets from private banks, in this case, the Somaliland Money Transfer Companies- by allowing the money transfer companies to become fully fledged Commercial Private Banks.

The private banks will expand the money supply further as they make loans. Once such a system was in place and trusted by the public, The Hawala system is no longer necessary.

The power both to print money directly and to regulate the creation of money by private banks carries a great deal of responsibility. In some countries, the fear of abuse of such power has led to the evolution of governance structures for central banks which distance them from day-to-day politics. Both the United States and Germany have central banks with a certain amount of 'independence' from the executive and legislative branches of government. Other countries, most notably Great Britain, put the central bank under the direct control of the treasury minister.

Functions and Tools of Central Banks
Although the Bank of England was chartered in 1694, it took several centuries to develop the institutional arrangements which could partially tame the banking system. The United States did not even establish its central bank, the Federal Reserve, until 1913. The Great Depression found most of the world's central banks either unwilling or unable to prevent the global banking system from crashing. The Federal Reserve was exceptionally pathetic during that crisis. However, central banks continued to evolve: at present their major responsibilities are to prevent banking crises and to control the flow of money though the economy. The primary function of a central bank is to prevent liquidity crises. If there is a run on a bank, the central bank can provide the threatened bank with sufficient currency to accommodate the depositors.

Controlling the Flow of Money
The central banks' other major role is to control the flow of money through the economy. One of the ways they do this is by requiring banks to hold part of their deposits as required reserves. The higher the required reserves, the less money banks can create by making loans. If a central bank were to set required reserves at 20% of deposits, and $1,000,000 found its way into the banking system as new deposits, banks could initially make loans totaling $800,000. The other $200,000 would be held as reserves. But the $800,000 in new loans would also become bank deposits. Then with $800,000 in additional deposits, the banks would be able to make $640,000 more in loans. Since the loaned amounts will continue to add to bank deposits, the banks will be able to make another $512,000 in loans out of the extra $640,000 in deposits. And on and on it goes, until the original $1,000,000 has multiplied itself into $5,000,000. If the reserve requirement were lower, 10% for example, banks could loan even more money (90%) at every step of the process, and the $1,000,000 could eventually become $10,000,000.
The Money Multiplier:

A central bank can increase the reserve requirement to slow down the growth of the money supply or decrease the reserve requirement to speed it up. But changing the reserve requirement is often regarded as too large a move. The reserve requirement establishes the leverage that deposits entering or leaving the banking system can have on the entire monetary system. The money multiplier can be calculated by dividing 1 by the reserve requirement. A reserve requirement of 10% (0.1) gives us a money multiplier of 10. That would mean that any new deposits getting into the banking system could multiply themselves 10-fold through the process of banks making loans which themselves become deposits, as noted in the paragraph above. Instead of changing the reserve requirement - which is done rarely - the central bank normally affects the money supply by injecting money into or draining money from the banking system.

If the banking system has made too many loans and does not hold sufficient reserves, the central bank might loan money to banks to bring their reserves up to the required levels. By increasing or decreasing the interest rate charged for these loans (called the discount rate in the United States and the bank rate in Great Britain) the central bank can either discourage or encourage the lending activities of banks.

Open Market Operations:
Central banks can also get money into the banking system or drain money from the banking system by purchasing or selling financial assets. When a central bank buys financial assets it pays in an (electronic) check. This check is in fact newly created money - it didn't exist before the central bank deposited it in a private bank - and it allows the private banks to make more loans to the public and expand the money supply further as described above. When the central bank sells financial assets, the buyer writes a check (drawn on a private bank) to the central bank. This money then disappears from the banking system; the banking system will have fewer deposits and will have to contract its loan-making activities, which will further reduce the amount of money in the banking system. The Federal Reserve gets money in and out of the banking system by buying or selling U.S. Treasury bills, notes and bonds. These purchases and sales are carried out through a small number of Wall Street bond brokers and are called Open Market Operations.

In the United States, the usual practice is for banks to borrow money from other banks before borrowing from the Federal Reserve. At the end of the banking day, a bank that has insufficient reserves to meet its Federal Reserve obligations will usually borrow from a bank that has excess reserves. It will borrow the money overnight and repay the loan in the morning.
 

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