Global Courant 2023-05-10 16:15:23
The South African Reserve Bank (SARB) has implemented a new toolkit to assist in the implementation of monetary policy in the country.
Speaking at the CFA Society South Africa & Investec Breakfast Conversation on May 10, Rashad Cassim, the deputy governor of the SARB, said South Africa is one of the first emerging markets to adopt a new method of monetary policy implementation, such as can be seen in countries such as New Zealand and Norway.
Monetary policy broadly refers to the process by which central banks such as SARB manage the supply and demand of money to achieve economic objectives such as price stability and economic growth.
The latest decision by the SARB’s Monetary Policy Committee (MPC) was the surprise move to raise interest rates by 50 basis points at the end of March. This increase brought the repo rate to 7.75% and the prime lending rate to 11.25% – a 14-year record.
Economists and analysts now expect a further rate hike in May as the SARB tries to cool inflation.
New system
SARB’s new monetary policy implementation framework (MPIF) was phased in in June and August last year and allows for limits on how much retail banks can leave with the central bank until they earn lower policy rates.
This prevents banks from hoarding reserves and ensures a well-functioning interbank market.
According to the Cassim, banks are getting a larger supply of reserves (known as settlement balances) than they need to meet reserve requirements and make interbank payments.
Essentially, there is now a surplus of bank reserves that can be relied upon when crises arise, such as the pandemic, for example. Previously, the old system suffered from a shortage of bank reserves.
Cassim said the SARB had made money to help the banking system through loan creation. He explained the method by which the bank created a sum of money and gave the following example:
“A bank takes a deposit and that deposit meets the definition of money – this is, for example, the money you have in the bank. But then the bank lends, for example, to someone who borrows for a car or a house.”
“And that loan also appears as a deposit with a bank, which is also money. In this way, the act of credit creation expands the money supply,” said the deputy governor.
He said having extra money available means the SARB can stop draining liquidity and end operations allowing banks to hold extra money instead, on which to earn the policy rate.
“The logic of this system is that abundant liquidity puts downward pressure on interest rates. But the deposit facility is a floor: it is not attractive to lend to someone else or buy assets with a lower yield than what the SARB offers. For this reason, these frameworks are often referred to as floor systems,” says Cassim.
The reason for building a larger surplus is simple, Cassim said.
“It is cheaper, easier and less disruptive to pay repo on excess bank reserves in quota than to manage this liquidity with other instruments. The size of the surplus is therefore based firstly on the amount sufficient to keep rates close to the bottom and secondly on what efficient management of the SARB’s liability structure yields. ”
Under the new system, SARB could inject liquidity into the market during periods of financial stress to stabilize the overall system without compromising the freedom of the monetary policy committee to select an interest rate.
“The next time we go through a crisis, we expect the financial system to start out more resilient, given a larger pre-existing liquidity pool. And if this proves insufficient, we have powerful tools to inject further liquidity,” said Cassim.
These changes being made behind the curtain of the general public are likely to have modest effects on day-to-day financial interactions; however, from a broader operational perspective for the central bank, these are major changes.
SARB said the reform would have a handful of implications for the larger economy.
Due to its efficiency, the new framework will save and improve money for the broad public sector and facilitate further credit extensions by increasing liquidity and reducing liquidity risks for lenders.
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