The money market’s response to regulatory adjustments amidst the Coronavirus pandemic

Brief overview of the money market

The money market is a segment of the financial market in which wholesale short-term loans and deposits are exchanged, or where short-term financial instruments are traded.

Activities on this market span from Treasury bills, Central Bank’s Repurchase Agreements (Repos) and Reverse Repos, Overnight Placements and Borrowings, Commercial Papers, Fixed Deposits (FDs) with maturities less than a year, Bank Certificate of Deposits, Forex and Swap Market among others.

This segment of the financial market is crucial to financial development as it shifts large sums of loanable funds between banks, provides a means by which surplus funds of cash-rich corporates and other institutions can be channeled to banks, corporates and other institutions that need short-term funds.

Governments also resort to this market for its short-term funding needs. It is worth noting that, activities of the participants in this market influence the evolution of short-term interest rates and growth in money supply.

An essential function of this market is the re-allocation of liquidity originally supplied by the Bank of Ghana (BoG) to offset anticipated and unanticipated liquidity imbalance in the market. Depending on the goal of monetary policy, key policy variables are adjusted to regulate monetary policy transmission mechanisms.

The novel Covid-19 pandemic wreaking havoc in most nations has resulted in diverse policy interventions by central banks across the global financial landscape. This article focuses on the Placement (Lending) and Borrowing aspects of the interbank money market in Ghana. It highlights the evolution of liquidity on the interbank placement and borrowing segment following the policy interventions of the BoG amidst the global Covid-19 pandemic. In the ensuing section, we discussed the response of the money market to recent adjustments to three key policy variables.

Policy Interventions and Market Response

On March 18, 2020, BoG simultaneously reduced Monetary Policy Rate (MPR) and Primary Reserve Requirement Ratio by 150 and 200 basis points (bps) to 14.5% and 8% respectively. The reduction in the reserve requirement ratio released additional liquidity to the financial institutions. Thus, BoG admonished Banks and Special Deposit Institutions to desist from investing these funds in Government of Ghana (GoG) and BoG securities.

The rationale for these adjustments was to provide more liquidity to banks to support critical sectors of the economy. Transactional rates for repo operations (i.e. borrowing and lending) with BoG were also revised on March 25 as follows: 1. Normal liquidity operations to be held from 10.00 am to 12.30 pm at MPR +/- 100 bps. 2. Late liquidity operations to be held from 3.00 pm to 4.00 pm at MPR +/- 500 bps.

MPR is a nominal interest rate that BoG sets in order to influence the evolution of monetary aggregates and other macroeconomic variables such as inflation rate, exchange rate and credit expansion among others. Any adjustment made to this rate reflects the prevailing macroeconomic condition and monetary policy stance by the central bank. Policy rate is indicative of the rate at which BoG lends to the commercial banks which in turn influences the cost of loanable funds to businesses and individuals.

However, on the interbank money market, this rate plays a seemingly more important function. Currently, the 14-Day and 56-Day BoG bills which are the major financial instruments of BoG’s Open Market Operations attract exactly the MPR as the rate of return for investing in them.

Hitherto the announcement of the reduction in MPR and primary reserve ratio, a number of the commercial banks were consistently borrowing on the interbank money market. On extreme occasions, some banks resorted to BoG at rates above the policy rate. This situation was puzzling as the financial sector had recently undergone a total financial cleansing and banks have become well-capitalized. The excessive borrowing on the interbank market can be partly attributable to short-term liquidity challenges and funding mismatches.

Around that same time, Covid-19 was impacting severely on businesses thus limiting the volumes of financial transactions and aggregate spending. One could easily make inference that the outbreak of this pandemic disease aggravated the liquidity positions of commercial banks. However, the simultaneous cuts in MPR and primary reserve ratio have miraculously overturned the fortunes of the money market.

Most banks that had short-term funding gaps particularly those that were bailed by the Ghana Amalgamated Trust (GAT) began holding long cedi positions.

How did these policy interventions overturn the fortunes of these banks? The commercial banks mostly invest their surplus funds in GoG and BoG’s short-term securities with the view to improving their interest income margins. With the cut in MPR, these BoG bills are currently unattractive to the commercial banks and as such, some are re-directing funds to other lucrative businesses that may fetch returns in excess of the MPR. Even if they wished to invest more of the released liquidity into these bills, it is not possible due to the stringent directive associated with the released liquidity.

Thus, the explicit guidelines regarding the use of this released liquidity as stated earlier and the mandatory reporting of daily money market activities has indeed inundated the money market with excess funds.

The revision of the transactional rates for repo operations further augmented and improved the effectiveness of the cuts in the monetary policy variables. Most highly liquid banks noting that, the previous repo rates of MPR +/- 100 bps were less punitive, preferred to deal with BoG than their counterparts—partly because the financial cleansing exposed a number of financial engineering such that, even with provision of full security cover for borrowed funds, some banks were not comfortable with interbank money market dealings.

With the new punitive rates for late liquidity operations held from 3.00 pm to 4.00 pm at MPR +/- 500 bps, more liquid banks are now opening up to their counterparts but with increased risk management, thus stabilizing market liquidity situations. Further, this has provided an opportunity for counterparties to strongly negotiate repo rates on interbank market before concluding deals since it will be less punitive lending to a fellow bank than placing with BoG. Interbank overnight interest rate is gradually falling to an appreciable level in response to the adjustments made to these policy variables.

The daily interbank rate was hovering around 16.13% prior to these policy interventions but currently stands at 13.90%.

Conclusion

All other things held constant, the releasing of liquidity through adjustments of the discussed policy variables and strict guidelines given have provided some form of relief to the money market. Thus, we commend BoG for these timely interventions and do hope that they keep up the good works.

As the impact of Covid-19 dwindles and business activities gradually return to normal, we will continue to monitor the evolution of liquidity on the interbank money market in the wake of subsequent policy revisions.