Political policy affects government policies
Political policy affects government policies which in turn affects the monetary policy of the country. Before looking at how politics affect bank failure one needs to understand the working of monetary policy. Monetary policy manages how banks in the economy functions.
Monetary policy means varying the price and supply of money circulating in the economy. It is more flexible than fiscal policy since changes can be made at any time. In addition, the effects are less obvious. The two monetary measures are designed to reduce total spending by raising the cost of borrowing and limiting the availability of loans. The money supply comprises mainly bank deposits and as monetary controls is intended to regulate this major form of money. Politics also influences fiscal policy that is on how taxes of the country are collected. These taxes can accelerate development or reduce development. However banks are mostly affected by the monetary policy and are as a result of political policy of a party.
Open market operations consist of selling or buying of government securities by the reserve bank on the market. If the bank sells securities, buyers pay by means of cheque drawn on the commercial banks. The balances of the commercial bank at the bank, will therefore, be reduced and if the reserve assets ratio is to be maintained, then bank advances must be reduced.
Funding is an aspect of open market operations. It means lengthening the age structure of the national debt by issuing less short – term debt that is the sale of treasury bills through the discount houses and more long-term or funded debt. In this way the reserve bank can alter the banks’ opportunities to purchase liquid assets, because treasury bills are easily converted into cash. Thus, if the bank wishes to decrease the money supply, the sale of treasury bills is restricted by converting the desired amount of short- term debt into funded debt. Consequently the banks must seek alternative liquid assets to reduce deposits.
Issuing directives open market operations and calls for special deposits are insufficient in themselves to achieve full control over bank advances. For example, instead of reducing their advances, the banks may prefer to sell their investments. Therefore, the central bank may supplement its action by issuing directives to restrict loans.
Changes in the bank rate influence other rates of interest. When bank rate is raised, borrowing becomes more expensive and demand for loans is reduced, thereby reducing purchasing power. Conversely a reduction in the bank rate will lead to an expansion of bank deposits. The resulting fall in overdraft rates will encourage borrowing, while saving will be discouraged because of the lower rate of interest paid on savings.
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