Lowering the Interbank Rate, A Pre-Requisite
By Mahdi Goodarzi & Mojde Rezaee
After lowering the inflation rate, the government started to drag other related economic indices down and managed to put the interest rate on a descending path, having supported stricter financial discipline and implemented correct monetary policies. Over the past 4 years, the Central Bank of Iran decreased this rate twice to stand at 15% on banking deposits and 18% on facilities granted.
Despite arising from so many factors, some experts, including Kamran Nadri, the Head of the Islamic Banking Group, see the following three contributing the most to sky high interest rates: banks’ weak financial and monetary structures resulting from credit crunch, high cost of money and overdue claims plus deposits flow to parallel markets which raises the probability of banks’ assets getting stuck. As long as such reasons exist, lowering the interest rate by decree will not yield any results but the weakening of state-owned banks.
Taking into account the consequences of high interest rates, managing the interbank rate, as one of the efficient factors, is of high significance; as a monetary instrument, the interbank lending market helps the CBI in lowering the interest rate. Being lowered from 28% to 18% in 2015/16, this rate reached 18.8% over 2016/17. However, the increase in banks’ debt to the CBI in the recent years demonstrates a rise in consumption than the volume of resources; in fact, the granted facilities to deposits ratio (after deducting the legal requirement) has surpassed the international standards, which has ended in higher demands in the interbank market, preventing this rate from coming down.
What has Happened in the Interbank Lending Market?
Injecting resources to the interbank market, turning banks’ overdraft with 34% fine rate into in-expensive credit lines with less than 20% rate along with lowering the legal requirement ratio for good banks (those with strict financial discipline), the CBI attempted to decrease the interbank rate from 28% to 18%, which led to the decline in banks’ cost of money, granted facilities rate and the interest rate.
Furthermore, the transactions volume in the interbank market has been constantly increasing compared with the total liquidity in the country, signaling the deepening of this market.
In this regard, it is worth mentioning that the moves towards pulling Iran’s economy out of recession, specifically after the JCPOA was struck, have added to the money volume growth rate, reaching from negative territories to 10%; considering the faster and more powerful effects of money volume growth on the inflation rate (rather than the quasi money volume growth), this has increased the risk of higher inflation rates. As the result, it must be kept in mind that too much focus on lowering the interest rate by resorting to the monetary policy via the interbank lending market might act otherwise, counteracting everything being done.
The statistics recently released by the CBI, nevertheless, shows that the interbank rate has reached 19% in the current year, although the inflation rate hovers around 10% at most. This proves that the market is not ready for more decline by decree, for which paying attention to banks’ balance sheets and implementing structural reforms seem necessary; in fact, many assume that even the current 18% facility rate has not been set under balanced conditions.
Challenges in the Interbank Lending Market
The Majlis Research Center has named the following as the challenges in this market:
- Lack of releasing banks’ credit ratings by the CBI and commercial banks’ lack of knowledge about credit risk levels of other banks have in fact raised the risk of activating in the interbank market.
- In addition, some experts believe that good banks must be separated from bad ones (in terms of their balance sheets) because transactions by bad banks are done at higher rates, violating the set rules and therefore, pushing us further away from accomplishing the goal.
- Another issue is that the CBI has not found a solution for banks’ frozen assets problem, which itself raises the cost of money for banks.
- The interbank market in developed countries benefits from their secondary markets and many instruments, which calls for more attention to ways the TSE, IFB, IME as well as other regulatory bodies, including the CBI, the Audit Organization, etc. will contribute to tackling the current shortages.
In order to lower the interest rate, the interbank rate must be dragged down in addition to many other steps to be taken; to do so:
An independent unit must be formed in the CBI to organize the interbank operations, the Interbank Regulation Unit must be strengthened, and there must be an independent Oversight Unit (separate from the Operating as well as the Implementing units), although a close cooperation must be set among them as well.
Besides, the secondary interbank market must also be developed to own the capacity of trading financial instruments just like the TSE and IFB, which itself stress on the existence of credit rating organizations.
Setting a reasonable rate (or range), the CBI must put an end to those banks’ opportunistic behaviors in supplying resources with high interest rates for other banks at the time of emergency; this way, banks have to offer lower rates in order to compete with the CBI interbank rate.
Furthermore, despite having an expansionary effect on liquidity, this act by the CBI will exert less inflationary effect, since its rate on facilities will be definitely lower than the 34% set for banks’ overdraft, and can act as a mechanism to discipline the banks.
In fact, by lowering the interest rate at which banks acquire their liquidity, they will accept lower risk, which will reduce the probability of banks’ resorting to speculative actions hoping to cover high rates both for paying back facilities and the overdraft from the CBI.
Last but not least, the CBI must set the payback period in harmony with each bank’s performance and rating; the higher the bank’s credit at the CBI, the longer its payback period might take and apart from encouraging measures, penalties such as changes to the banks’ managerial levels (for instance if the violation gets repeated foe consecutive periods) can be done to kill any intention for ignorance and put all banks on the right path.
DISCLAIMER: This report has been prepared and issued by Agah Brokerage Firm on the basis of publicly available information, internally developed data and other sources believed to be reliable. The information contained herein is not guaranteed, does not purport to be comprehensive and is strictly for information purposes only. Agah does not assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. Any expressions of opinions are subject to change without notice.
To contact reporters: Inter@agah.com