Relationship between the Central Bank and Commercial Banks
The Central Bank is the head of the financial system. All financial institutions including commercial banks are regulated and monitored by the Central Bank.
All commercial banks must keep an account with the Central Bank. These balances are used for cheque clearing purposes between banks. Payments for cheques between banks are set off at the Central Bank’s clearing house. The Central Bank can also demand commercial banks to deposit a certain percentage of their total deposits with the central bank in order to control the money supply.
The Central Bank is a lender of last resort and will aid commercial banks when needed. The Central Bank dictates the interest rate that commercial banks can offer by setting the bank rate. This is the interest rate set by the Central Bank and the rate at which commercial banks and the Central Bank do business, e.g. loans offered by the Central Bank to commercial bank.