Over the last month, several commercial banks in Botswana have hiked their lending rates. This is although the Bank of Botswana's Monetary Policy Committee (MPC) has kept the Monetary Policy Rate unchanged over its last four sittings, since August 2024.
Bose Mathanjane, a finance professional with 8 years of experience in financial markets analysis, expounds on the rationale behind the hikes, impact on households and businesses, and much more.
The current economic environment in Botswana presents a compelling case study in monetary policy transmission and market dynamics, particularly amidst a prevailing market liquidity squeeze. The recent decision by the Bank of Botswana (BoB) to grant commercial banks greater autonomy in setting lending rates, independent of direct changes to the Monetary Policy Rate (MPR), has led to an intriguing paradox: commercial banks have opted to increase lending rates despite the MPR remaining unchanged. This essay will critically examine the rationale behind commercial banks' decision to hike rates, evaluate the effectiveness of the BoB's policy shift, analyse the multifaceted impact on households and businesses, and assess the broader relevance and efficacy of monetary policy under this evolving setup.
Commercial Banks' Rationale for Hiking Rates Amidst a Liquidity Squeeze
A market liquidity squeeze refers to a condition where there is a scarcity of readily available funds in the financial system, resulting in an increase in the cost of borrowing for financial institutions. For commercial banks in Botswana, this translates into higher interbank lending rates and potentially increased costs for attracting deposits. In such an environment, the decision to raise lending rates, even without a corresponding increase in the BoB's MPR, is a rational response driven by several commercial imperatives:
Firstly, cost of funds management becomes paramount. When interbank liquidity tightens, banks must pay more to secure the funds necessary for their lending operations. If the cost of their liabilities (deposits and wholesale funding) increases, maintaining profitability necessitates an adjustment to the pricing of their assets (loans). The "free will" granted by the BoB allows banks to pass on these increased funding costs to borrowers, thereby protecting their Net Interest Margins (NIMs), which are crucial for their financial health and sustainability.
Secondly, risk premium adjustments play a significant role. A liquidity squeeze often signals heightened systemic risk or increased uncertainty in the economic outlook. In such circumstances, banks may perceive a higher risk of default from borrowers, particularly those with precarious financial positions. Consequently, they incorporate a higher risk premium into their lending rates to compensate for this elevated risk, even if the central bank's policy rate remains stable. This is a fundamental aspect of risk-based pricing in a competitive financial market.
Thirdly, the development of the interbank market might be an underlying factor. If commercial banks are less reliant on the central bank for liquidity and are instead forced to source funds from each other, the interbank market becomes more active. The pricing in this market (e.g., the Botswana Interbank Offered Rate - BIBOR) will reflect actual liquidity conditions. By allowing banks to price their loans based on their true cost of funds from this market, the BoB's policy implicitly encourages a more robust and responsive interbank market, as hinted at in the broader policy objectives of the Bank of Botswana.
Effectiveness of the Bank of Botswana's Policy Shift
The BoB's decision to grant commercial banks greater autonomy in setting lending rates likely stems from a desire to foster a more market-driven interest rate environment and potentially deepen the interbank market. The previous "PRESS RELEASE - EXCHANGE RATE FRAMEWORK FOR 2025" highlighted a similar intent to promote an inter-bank foreign exchange market by widening trading margins. This new policy could be seen as an extension of this philosophy, aiming to reduce commercial banks' reliance on the central bank for liquidity and allow market forces to determine the true cost of credit.
However, the immediate outcome—commercial banks hiking rates despite a stable MPR—raises questions about the policy's effectiveness in achieving its broader macroeconomic objectives, particularly price stability and supporting economic growth. If the MPR, traditionally the primary signaling tool for monetary policy, is no longer the sole determinant of commercial lending rates, its transmission mechanism could be weakened. Banks' independent rate adjustments might dilute the BoB's ability to influence aggregate demand and inflation through its conventional policy rate. While this move might enhance the responsiveness of the banking sector to liquidity conditions, it simultaneously introduces a layer of complexity and potential unpredictability into monetary policy implementation. The effectiveness hinges on whether this market-driven approach ultimately leads to more efficient capital allocation and a more resilient financial system, or if it exacerbates economic challenges by increasing the cost of credit when the economy is already under pressure.
Impact on Households and Businesses
The decision by commercial banks to increase lending rates has tangible and often adverse impacts on both households and businesses in Botswana.
For households, higher interest rates directly translate to increased debt servicing costs. This is particularly acute for those with variable-rate mortgages, personal loans, or credit card debt. The erosion of disposable income due to higher loan repayments can lead to a reduction in consumer spending, which forms a significant component of aggregate demand. Furthermore, this increased financial burden raises the risk of loan delinquencies and non-performing loans (NPLs), potentially straining household balance sheets and, in turn, the asset quality of commercial banks. New borrowers also face higher entry barriers to credit, dampening demand for housing and other large purchases.
Businesses, especially Small and Medium-sized Enterprises (SMEs), are also significantly affected. Higher borrowing costs for working capital and investment loans can reduce profitability, deter expansion plans, and stifle innovation. For businesses already grappling with the liquidity squeeze, increased lending rates can push them towards financial distress, potentially leading to job losses and even insolvencies. Large corporates, while often having more diversified funding sources, will also face higher costs of capital for major projects, potentially slowing down private sector investment that is crucial for economic diversification and job creation. The cumulative effect can be a slowdown in overall economic activity and a dampening of business confidence.
Relevance and Effectiveness of Monetary Policy Under the Current Setup
The current setup challenges the traditional understanding of monetary policy relevance and effectiveness in Botswana. If commercial banks' lending rates are primarily driven by market liquidity conditions rather than solely by the MPR, the BoB's primary policy tool might lose some of its direct influence over the cost of credit in the real economy. This does not necessarily render monetary policy irrelevant, but it mandates a re-evaluation of its transmission channels and the need for complementary tools.
The BoB's crawling band exchange rate framework, designed to maintain competitiveness and price stability, remains a critical component. However, if domestic interest rates are decoupled from the MPR, it could create inconsistencies. For instance, if the BoB aims to stimulate the economy by lowering the MPR, but commercial banks keep rates high due to liquidity constraints, the intended stimulus may not reach households and businesses effectively.
- Enhanced Liquidity Management: More proactive and targeted open market operations to inject or withdraw liquidity from the banking system, directly addressing the root cause of the squeeze.
- Clearer Communication: Transparent communication regarding its expectations for commercial bank lending rates and the rationale behind its policy decisions, to guide market behaviour.
- Macroprudential Tools: Utilising macroprudential measures to manage credit growth and systemic risk, rather than solely relying on the MPR.
- Monitoring the Interbank Market: Closely monitoring the development and efficiency of the interbank market to ensure it functions as an effective channel for liquidity distribution.