The latest monetary policy framework, which the National Bank of Rwanda (BNR) begun implementing last month, could strategically promote inter-bank lending market which has shown positive trends for the past few years.

This is according to officials and sector experts interviewed by Business Times.

Last week, the Central Bank released the Monetary Policy and Financial Stability Statement under the new policy with officials saying that one of the anticipated unique aspects is to drive the interbank market.

Simply put, interbank lending market or interbank markets is where banks lend to other banks. With banks often requiring heavy capital amounts, the venture has huge potential to further drive up the performance of the financial sector.

Kigabo said that the move  will enable banks to satisfy the big demand of loans from their customers.

Apart from the loans being of huge amounts, they are generally offered without any collateral and for a very short duration of time. The average interbank loan is for overnight purposes.

These markets provide banks with the liquidity required to make loans without being constantly worried about deposits.

The Chief Economist of the Central Bank, Thomas Kigabo told Business Times that they see the new policy framework driving the interbank market and positively affecting different economic activities.

"When banks are confident that they can always borrow and lend among themselves, there is never emotion of fear of giving out loans to businesses and ordinary citizens. Another big question they then ask is at which interest they will be able to borrow from the other bank – the interbank interest rate. As a central bank we influence this rate and this is what the new policy framework intends to do,” he said.

This, he added, will enable banks to satisfy the big demand of loans from their customers.

In the new monetary policy framework, interest rate will be used as an operational target as opposed to quantitative targets (quantity of money) such as reserve targets as the previous monetary policy previously targeted.

The price-based monetary policy is set in a sense that the management of deposits and behaviour do not change very much, and it responds to modern behaviour changes and technological changes.

"Ten years ago, a citizen would earn Rwf100,000 and spend Rwf80,000 and save Rwf20,000. But today, it is the other way round. In addition, people are using different technology tools. This means change in money management,” the chief economist noted.

Since 2013, the inter-bank market has been increasing, recording good developments both in number of transactions and volume exchanged.

According to the recent central bank statistics, in 2013, the interbank market recorded Rwf146 billion through only 97 transactions. Last year alone, the interbank market recorded Rwf677 billion in 337 transactions.

Statistics also show that money market interest rates have been converging towards the central bank rate and have been less volatile, which they say, is a result of good liquidity forecasts and management.

At the end of 2018, the central bank rate remained unchanged at 5.5 per cent after cutting the policy rate 3 times since 2016. Money market interest rates followed the trend in the central bank rate with average repo rate, treasury bills and interbank rates declining to 4.22 per cent, 5.09 per cent and 5.57 per cent in 2018, respectively, from 4.56 per cent, 6.91 per cent and 6.11 per cent in 2017.

The same year, commercial banks’ lending and deposit rates decreased by 21 basis points, respectively standing at 16.96 per cent and 7.51 per cent, which indicates positive developments in monetary policy decisions.

Maurice Toroitich, the Chief Executive Officer of BPR, argues that increased interbank borrowing and lending does not necessarily correlate to increase lending to private sector.

"It is a market where banks obtain liquidity or invest excess liquidity. However, certain loan transactions in an individual bank might cause that bank to want to go to the market to raise funds to support the loan on a short term basis if they do not have sufficient liquidity from customer deposits at that time to make the loan,” he said.

In that case, he added, the interbank market can help banks to be more confident in their lending operations when they are faced with short term liquidity shortage.

Toroitich, however, agrees that the new monetary policy could promote interbank market if all market players work together.

"Price based monetary policy relies on an efficient money market system where all the actors in the market act rationally to increase their respective value or to manage risk in the market,” he said.

Five years of preparation

Kigabo told this paper that they have been preparing themselves for the past five years to adopt the new monetary policy framework, which allowed more flexibility and built foundation for the use of the new policy.

They, among other things, introduced changes in monetary policy framework, including the introduction of key repo rate in 2008 as a policy rate, initially to support commercial banks in their liquidity management.

"Since 2010, key repo rate was used as a tool to signal monetary policy stance, while retaining reserve money as the operating target. To reduce undue interest rate volatility and accommodate the uncertainty of monetary targets, central bank also introduced a flexible monetary programming framework in 2012,” Kigabo explained.

The central bank says to contribute to the development of interbank market; the bank’s interventions on money market will ensure that interbank rates remain attractive.

Believably, the interbank market represents the first link of liquidity trading in the economy and the transparent price setting mechanism. It allows the financing of short and medium term positions and facilitates the mitigation of commercial banks’ business liquidity risk.

Kigabo said it also facilitates the smooth financial intermediation – process where firms pool savings and investments and lend or invest them – and enhancement of lending to the economy.

Many economists believe the borrowing and lending between banks is an important component of the banking system. When the interbank market stops operating, chaos breaks loose.

Such a situation was witnessed in 2008 after the collapse of Lehman Brothers, one of the largest financial institutions in the US. Banks were scared of counterparty risks that would arise because they were not sure of the financial health of the other institutions. As a result, the interbank market completely froze.

Since the interbank market froze, banks also had to stop making loans because they were not sure if they could meet the reserve requirements. This led to the banking system to come to a grinding halt plunging the world into a recession and increasing scares of systemic failure.

editorial@newtimesrwanda.com