- Central bank proposes changes on how monetary policy operates
- Bank rate is being replaced with policy rate
- Targets to influence pricing of deposits
- Caps Prime Lending Rate
BoB explains that the policy rate will affect the supply side of funds rather than the demand side which the bank rate influences. The 7-day BoBC yield was 1.11 percent as at 22 February versus the 3.75 percent current bank rate.
Governor Moses Pelaelo announced that the central bank will adopt and designate the yield on the main monetary operations instrument (currently the 7-day BoBCs) as the anchor ‘policy interest rate’. According to Pelaelo, it will be called Monetary Policy Rate; replacing the Bank Rate. He stresses that the monetary is only changing how it operates by targeting banks’ deposits.
A bank’s balance sheet has the sources of fund (liability) and uses of funds (assets). The central bank explains that the bank rate targets uses of funds which is the asset side while the policy rate targets sources of fund (deposits). The bank’s officials say “we are moving away from the other side”.
For the bank to have effective monetary policy, they believe it need to target the banks’ deposits while the assets side (loans) become a residual. It will then be a determination of banks as to how much they would charge clients based on liquidity conditions, credit worthiness and other risks. “What we are trying to do is to target raw materials they are dealing with in terms of pricing. So that what we do will influence directly the liability side of the balance sheet of the bank,” Pelaelo buttressed.
By doing so, some analysts who spoke to this publication point out that the monetary policy rate will more closely reflect liquidity conditions and BoB will be better able to influence liquidity. Their point is that the BoB hardly lent to commercial banks at the Bank Rate; the Bank rate was never really a good steer for monetary policy in Botswana. “The policy rate is to affect how the banks operate. If you recall, the bank rate is a rate at which banks would borrow from the central bank and this does not happen frequently,” Dr Kealeboga Masalila, Deputy governor explained. “Whereas with respect to the Bank of Botswana Certificates there are weekly auctions therefore there is regular activity that will affect banks operations including how they price their deposits as well as lending interests rates.”
Pelaelo announced a number of changes that the bank expects will enhance potency of monetary policy transmission and enhance desired market response to adjustments to monetary policy and operations, designate an anchor policy rate capable of affecting liquidity management decisions of banks, and thus providing a direct link to policy changes. Further the changes aspire to achieve an interest rate structure that fosters an active interbank market that also projects the policy stance and desired impact of monetary operations on economy wide interest rates and help in the determination of the yield curve for government securities (that is, the cost of financing of budget deficits and infrastructure projects).
According to the governor, the auction format for the main monetary operations instrument (the BoBCs) will be changed from the current multiple price system to a fixed rate full allotment system. BoBCs rate was calculated on average basis from commercial banks’ bids every month. Banks buy this paper to manage their liquidity and it is actioned every 7 days. With the central bank now fixing it, experts worry that prescribing where it should be, scraps off the yield portions.
Should the central bank use current 7-day BoBC, economists argue that the change will effectively be a rate cut, unless the central bank pegs the yield rate at par with bank rate. But BoB has said reference rate will not be the same. Economists point out that keeping it at 1.1 percent means the real interest rate perspective widens given that inflation is at 10.6 percent; real interest rate will be 9.5 percent as compared 6.85 percent when the rate was 3.75 percent.
The key question as many digested the changes was whether the 7-day BoBC would start off where the bank rate is or whether it will jump to the bank rate in April. Assuming, the central bank was to start today, where the yield on the 7-day BoBC sits, indeed officials at the central bank agree that will be the anchor rate. While the bank says it has not set a date when changes will take effect, analysts argue that the bank will need to see the full year 2021 GDP figures, impact of geopolitical issues before making any decision on the rate changes. Another important factor that bankers consider is how the 7-day BoBC has been interacting with inflation for the central bank to consider it as a rate to be able to control inflation.
A 7-day BoBC was only introduced a few years ago. However, central bank is doing away with trade-weighted basis; depending on liquidity means of different banks, they would bid at certain levels. Hence it was based on market activity but now will be forced at a fixed rate. In addition to the changes, the Bank will also introduce a one-month paper (BoBC), auctioned once a month, that will help address some of the structural liquidity positions and support the construction of the short-end of the yield curve, especially since government treasury bills are not issued for this tenor.
Another key highlight is that Bank of Botswana will allow commercial banks to independently determine their own Prime Lending Rates (PLR) in order to foster the development of a competitive financial sector. However to ensure an orderly and smooth transition as well as treatment of pricing of existing financial contracts and other products linked to industry prime lending rate, governor Pelaelo announced that the current PLR of 5.25 percent should not be changed by any bank. Except in the event of an adjustment by the Monetary Policy Committee of the signalling policy rate, to be called the Monetary Policy Rate.
PRL is set 150 basis points above the bank rate. When the central bank adjusts the bank rate, the PRL automatically adjusts. Loans are based on the Prime Rate. Cost of borrowing to consumers is not going to go up and no bank is expected charge more than 5.25 percent. Unless banks are trying to build balance sheets, observers argue that this creates a race to the bottom being the policy rate. The narrative has been on what kind of guidance banks will take when the policy rate keeps increasing, the questions being where the tipping point for that cap to be removed is. The BoB has said it will engage with banks in due course.
Other changes include an interest rate corridor, with a 200-basis points margin, being established comprising a new Standing Deposit Facility at the Bank of Botswana at 100 basis points below the Monetary Policy Rate and a Standing Credit Facility at 100 basis points above the Monetary Policy Rate. “The Bank will, on a less frequent basis (two to three times within the Primary Reserves Averaging maintenance period), depending on the liquidity situation, undertake liquidity absorption or injection at the policy rate,” Pelaelo said.