In the midst of revoking SI 55 and SI 33 another piece of monetary news did not get much media coverage. [I may separately return to the abrupt SI changes in future posts].
The Bank of Zambia (BoZ) last week announced additional measures (on top of recent increase in reserve ratios) to tighten liquidity and prop up the Kwacha. The rate on its overnight lending facility (OLF) is now set at 6% above the policy rate. Prior to these changes the OLF was set at 2.5% above the policy rate, with interbank rates trending within a 2% range around the policy rate.
BoZ has also now restricted automatic access to OLF. Commercial banks will be able to access OLF only once a week. Banks will be required to meet their liquidity needs by borrowing in the interbank market. With liquidity in our banking system largely concentrated among a few institutions, this is will inevitably lead to much more pressure on overnight rates – even more than the 3.5% hike in the OLF rate implies.
Any bank needing to access the OLF more than once a week will be required to explain to the BoZ why it could not meet its liquidity needs by borrowing from other sources. If a bank should fail to repay an intraday loan, the BoZ will revert to a system of automatic rediscounting of securities.
Undoubtedly the above description will baffle some readers because it is a little bit technical. Unfortunately I haven't got all day to unpack everything. I defer to our many well informed media houses to put things in plain english. But not to worry, all you need to know is the following points:
- The OLF is important! Thats why I am writing about it!
- The measures are designed to strengthen the Kwacha by tightening the amount of "cash" available in the system. It will also raise the level of interest rates which should help dampen down inflation.
- The changes will simply increase the smaller banks dependence on wholesale borrowing and Interbank lending, both of which will see higher rates. This will put loads of pressure on the smaller banks, many of which are loss making presently. The larger highly liquid banks should be fine, particularly those with very high capital adequacy ratios. They'll likely ride the wave of high short term interest rates and make some money. Smaller banks will not be so lucky. Smaller banks may have to adjust for this by increasing transaction fees to buttress income, and adjust flow lower net interest margins. If they fail to do this some may fail / go broke or need a GRZ bail out.
- The measures will put a lot of pressure on the maximum lending ceiling - the result is that GRZ will probably revoke that soon! Its worth noting that 6% above Policy Rate is presently 16.25%, which is higher than the present 364 TBill yield. In fact its quite close to the present 10 year bond yield. We may begin to see an inverted / flat yield curve soon.
- It may potentially halt the sharp slide of the Kwacha in the short term (pulling back to K6 per $1) but the Kwacha will resume depreciation in the medium term until a new equilibrium is found that aligns the policy environment and the fundamentals.
I hope the above helps. And apologies that lack of time means I cannot make this any more simpler! And if I have missed anything, I am sure someone with better understanding will helpfully correct me!
These changes of course raises wider implementational issues. Why is there no genuine consultation when BOZ introduces these changes? Have these changes even be been "stress tested"? Where the last changes now abolished properly tested? If proper process had been followed before introducing many of these policy changes, including SIs 55 and 33 Zambia would not be backpedaling and introducing additional measures to resolve issues in the short term. In the end many of these prescription appear highly toxic and detrimental to the general goal of making credit widely available in order to foster private enterprise. But I guess only B
Chola Mukanga | Economist
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