The Reserve Bank will shake up the way it implements monetary policy from next week, with the launch of a new process for ensuring the Bank’s interest rate decisions feed through effectively to the rates at which commercial banks lend to consumers and businesses.
The Bank said it will change to a new monetary policy implementation framework over a 12-week transition period starting on June 8. This comes after extensive consultation on the details of the framework, which the Bank released for public comment in November. The Bank said it is working closely with bank treasurers and market players to ensure the transition is smooth.
The new approach, which is used by many central banks worldwide, implements monetary policy in a way that allows a surplus of liquidity in the money market. This is in contrast to the previous approach, which relied on the Bank engineering a deficit to force the banks to change their interest rates when the Bank’s monetary policy committee changes the repo rate. The plan is to move from a shortage of about R30bn at the start of the transition to a surplus of R50bn by the end of the 12 weeks.
This will not affect monetary policy itself but rather is about what happens between the Bank setting the interest rate and how this transmits through the banks to consumers and firms in the economy, Reserve Bank deputy governor Rashad Cassim said. “The new framework aims to enhance the plumbing of the financial system to ensure the monetary policy transmission system is more effective,” Cassim said.
Though any project has risks, Cassim said the framework is the product of painstaking consultation over several months. The Bank consulted closely with the banks at every level, as well as with international and local academics and emerging-market and developed country central banks and the IMF, and it is confident of the solid business case for the change. It has also put in place a very clear transition plan, working with the banks.
Reduce distortions
The Bank’s “overall view of the reform is that it will have limited consequences for asset prices or economic activity. Where it has effects, these will tend to enhance monetary policy transmission, particularly by removing distortions,” reads the Bank’s “Transitioning to a New Monetary Policy Implementation Framework” document, which was released on Friday with a revised version of the framework itself.
The new system is, however, expected to reduce distortions in the foreign exchange market, for instance for FX-implied rates, which market players say could make it slightly more attractive for foreign investors to buy SA’s domestic government bonds.
The rethink of the old framework, which was introduced in 1998, was prompted by the fact that it had become increasingly difficult to manage the old, shortage-based system over the past decade, because of increasing liquidity that built up in the economy as a result of capital flows and loans.
Globally, most central banks had moved to a surplus-based system, especially after the global financial crisis and the huge injections of liquidity that followed. For SA, the build-up of liquidity became a particular issue during the Covid-19 pandemic, when liquidity in the local market was boosted by billions of dollars of borrowing from international financial institutions as well as by the loan guarantee scheme and other interventions.
Hoard cash
In a deficit system, the central bank keeps the market short to force banks to go to the Reserve Bank “window” to borrow at the repo rate. With the new approach, the Bank will give up on engineering deficits and will instead pay banks interest on their excess cash, at the repo rate. That entrenches the repo as the floor for the price of money, because banks won’t lend to customers at less than they can earn by simply keeping their cash in reserve at the Reserve Bank.
But SA will also limit how much each bank can do this, capping the amount they can keep in reserve at the full repo rate to ensure they don’t hoard too much cash and that the interbank lending system continues to work smoothly.
The system involves all the banks who are members of the payment system, SAMOS. The quota or cap for each bank is set out in the document the Bank released on Friday detailing the timelines and technicalities of the phasing in of the new system.
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