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An Investigation into the Efficacy of Monetary Policy Transmission in

Mauritius

Prepared by Danielle Dobos


August 2014

The views expressed in this report are those of the author and should not be taken as the views of
the Ministry of Finance and Economic Development or as Ministry policy.

Abstract
This report examines transmission mechanism failures in the Mauritian monetary policy system.
We find that interbank rates do not follow policy rates set by the central bank of Mauritius due to
a buildup of excess liquidity in the system and other confounding factors. Possible explanations
for these factors include an underdeveloped market for government securities, an
underdeveloped interbank market, and imperfect competition in the banking sector. Available
data suggests that an underdeveloped secondary securities market and imperfect competition are
the most likely transmission mechanism failures and contribute to the buildup of excess liquidity
in Mauritius, although there is a need for further analysis with more comprehensive data to draw
definitive conclusions.

I. Introduction
Monetary policy plays an important role in combatting inflation and maintaining price stability
in modern economies. Its transmission mechanisms are well documented in high-income
countries with a large formal financial sector, but less so in low-income and middle-income
economies such as Mauritius.
Mauritius has experienced substantial macroeconomic success since its financial liberalization in
the 1980s. It ranks 20th in the world in the World Banks Ease of Doing Business score and saw
its inflation tumble from double digits in 2008 to a rate that now hovers between 3 and 5%.1
With price stability the primary mandate of the countrys central bank it would seem that
Mauritius enjoys successful monetary policy transmission; however, there have been doubts cast
on the efficacy of Mauritian monetary policy in the last decade. The central bank had difficulty
responding to foreign crises under its old policy rate regime2 and a recent working paper by the
IMF found evidence of a weak transmission mechanism under the new policy rate.3
Policymakers attribute this inefficiency to a build-up of excess liquidity in the banking system,
which has long been known to break down a central banks ability to employ open market
operations. While the government has made repeated attempts to sterilize this liquidity, the
persistence of the problem calls into question whether excess liquidity is the only breach in the
Mauritian monetary system or if there are deeper, underlying problems involving the
transmission mechanism at play.
This report will explore the efficacy of monetary policy transmission in Mauritius. The purpose
and structure of the report will be two-fold: Section II will investigate the efficacy of Mauritian
monetary policy and the role of excess liquidity by reviewing the four transmission mechanisms
of monetary policy, summarizing developments in Mauritian monetary policy history, and then
analyzing the transmission between current interest rates. Section III will explore possible
explanations for breaches in the Mauritian transmission mechanism beyond excess liquidity,
including an underdeveloped secondary market for government securities, underdeveloped
interbank market, and imperfect competition in the banking sector. Section IV concludes.

II. Mauritian Monetary Policy


A. The Four Primary Transmission Channels
The transmission mechanism of monetary policy refers to the channel through which changes to
the central banks policy rate affect aggregate demand and inflation. There are six primary
1

Bheenick, R. (2010, November).


The Bank of Mauritius switched from using the Lombard rate as its key policy rate to the key repo rate in 2003.
See Punchoo (2004).
3
Tsangarides (2010)
2

transmission channels, four of which are utilized in emerging economies: (i) The interest rate
channel (ii) The credit channel (iii) The exchange rate channel and (iv) the expectations channel.
Each of these channels begins through a change in the policy rate.
The Policy Rate Corridor
Central banks begin the process of changes in monetary policy by practicing open market
operationsthe purchase or sale of short-term government securities4. Under an expansionary
monetary policy the central bank would purchase short-term securities from banks, thereby
increasing each banks amount of free reserves.
This increase in reserve supply would result in a reduction of the interbank rate as banks find
themselves with larger amount of reserves to lend in the overnight interbank market. The
interbank rate should remain within a corridor set by the policy rate of the central bank. The
interbank should not dip below the interest rate at which the central bank sells securities or else
we would expect to see banks reallocate their reserves to purchase securities that provide a
higher rate of return. Conversely, the interbank rate should not climb higher than the rate at
which the central bank purchases securities, as cash-strapped banks could obtain extra funds by
selling securities rather than face the high rates of an interbank loan.
In this manner, the central bank can manipulate the interbank lending rate which then affects the
larger economy through the various transmission channels.
The Interest Rate Channel
The reduced interbank lending rate makes it less costly for banks to obtain funds. In a
competitive industry, banks should pass on these reduced costs to lower lending rates, and as a
consequence of a lower return on assets (both interbank loans and loans to the nonbank sector),
reduced deposit rates as well. This reduction in short-term interest rates affects household
savings and consumption decisions through the interest rate channel, where lower deposit rates
spur consumption and a higher aggregate demand.
The Credit Channel
The increase in bank reserves should also leave banks more willing to extend credit to the private
sector, increasing consumption and aggregate demand through the bank lending channel of the
larger credit channel. The bank lending channel functions properly when securities are not close
substitutes for depositsor in other words, when banks can make higher profits by providing
loans to the private sector than they can by purchasing more securities.
4

Many central banks, including the Bank of Mauritius, now use short-term repurchase agreements (repos or reverse
repos) where securities are traded for cash or vice versa and agreed to be repurchased at a later date. Repos carry a
lower credit risk than traditional open market operations and allow greater flexibility although their role as a
monetary policy instrument remains the same.

The Exchange Rate Channel


Decreased short term interest rates will lead to a depreciation of a countrys currency. A
depreciated currency will lead to a rise in demand for the countrys exports, increasing aggregate
demand and inflation through the exchange rate channel.
The Expectations Channel
Recent literature (Friedman & Kuttner, 2010) postulates that monetary policy can have a large
influence on interest rates through expectations of future interest rate changes rather than through
actual manipulation of the money supply. In this sense, central banks may be able to increase the
effectiveness of monetary policy with clear signaling of the policy rate and strong
communication to banks.
Box 1: Monetary Policy Transmission Channel
An Example of Expansionist Policy

Exchange Rate
Channel

Credit Channel
Interest Rate
Channel

Source: Author

B. Review of Mauritian Monetary Policy Framework


The Bank of Mauritius (BoM) operates as the independent central bank in Mauritius. Founded in
1966 with the core mandate of maintaining price stability, the BoM acts as both a regulator and
formulator of monetary policy. It would previously intervene directly in the reserve ratios and
interest rate spreads of banks, but underwent financial liberalization in the late 1980s. The Bank
of Mauritius now uses policy rates and open market operations to indirectly influence the
economy.
The BoM initially targeted reserve quantities and used the bank ratethe overall weighted yield
of weekly auctioned treasury billsas its key policy rate. The bank rate was market determined,
with the BoM only able to manipulate rates through controlling the amount of treasuries
auctioned each week, leading to a confusing, and often ineffective monetary policy framework.
The BoM was unable to raise interest rates in response to the rapid depreciation of the Asian
Crisis in 1998, prompting a switch to a new policy ratethe Lombard ratein 1999.
The Lombard rate is defined as the discount window rate, or the rate at which commercial banks
can borrow from the central bank as a lender of last resort. The Lombard rate enjoyed initial
success but a widening gap between the Lombard and the interbank rate prompted renewed
concern. In 2007, in keeping with international standards Mauritius switched to a corridor system
using the key repo rate (KRR) as its main policy rate. Under this system, the BoM sells securities
through repo transactions at a rate 50 basis points below the KRR, and purchases securities
through reverse repos at a rate of 50 basis points above the KRR. This corridor was widened to
125 basis points following the 2008 financial crisis.
Box 1: Timeline of Mauritian Monetary Policy
1967 Creation of the Bank of Mauritius (BoM)
1967 1986 Period of direct control over monetary policy: The BoM controlled monetary policy
through direct intervention with high reserve requirements, credit ceilings, and interest rate ceilings
1986 1996 Financial liberalization: The BoM gradually switched to open market operations to
control monetary policy by buying and selling BoM treasuries and acting as a lender of last resort
1987 Liberalization of Bank rate: The bank rate, the overall weighted yield of weekly auctioned
government treasury bills, was opened up to market forces and used as BoMs key policy rate.
1999 BoM switches to Lombard rate: In light of its inability to raise the interest rate to combat the
rampant depreciation of the Asian Crisis (1998), the BoM switched to the Lombard rate to signal its
stance of . The Lombard rate is the overnight lending rate for commercial banks to borrow from the BoM.
2004 Bank of Mauritius Act of 2004: The primary objective of the BoM to maintain price stability
and to promote orderly and balanced economic development was reinforced, and a permanent monetary
policy committee (MPC) was created
2007 BoM switches to Key Repo rate: A widening gap between the Lombard and in interbank rate
prompted the BoM to switch to the key repo rate (KRR) as its signal rate. The corridor for the interbank
rate was set at 50 basis points from the KRR.
2008 BoM increases corridor: The BoM increased the corridor breadth to 125 basis points in
response to the global financial crisis
Source: Punchoo (2004); Tsangarides (2010); Jankee (1999).

C. Analysis of the Current System


In light of past problems with the policy rate, it is prudent to evaluate the success of monetary
policy under the key repo rate corridor system. Each of the primary transmission channels of
monetary policy relies on successful pass-through from the policy rate to interbank lending rates,
with the interbank rate expected to remain within the corridor created by the KRR. Graph 1
demonstrates that this is not the case in Mauritius. Interbank rates fluctuate in and outside of the
KRR corridor from January 2007 to December 2008, and remain consistently below the reverse
repo rate after January 2009.
Graph 1: The Interbank and Key Repo Rate
16.00

KRR

14.00

Interbank

12.00

KRR + 125bp

10.00

KRR - 125bp2

8.00
6.00
4.00
2.00
0.00
Jan 07
Apr
Jul
Oct
Jan 08
Apr
Jul
Oct
Jan 09
Apr
Jul
Oct
Jan 10
Apr
Jul
Oct
Jan 11
Apr
Jul
Oct
Jan 12
Apr
Jul
Oct
Jan 13
Apr
Jul
Oct
Jan 14

(%)

Source: Data from BoM Monthly Statistical Bulletin.

Graph 2 quantifies the gap between the KRR and interbank rate. During the period from January
2007 to March 2008 the interbank rate remained with the original 50 bp corridor 7 out of 15
months a 46.67% success rate. After the corridor was expanded to 125bp in April 2008, the
interbank rate only remained within the KRR corridor 7 out of 73 monthsa 9.56% success rate.

Graph 2: The Gap between the KRR and Interbank Rate


6.00

(%)

Gap (KRR - Interbank)

5.00
4.00
3.00
2.00
1.00

50 bp

125bp

-1.00

Jan 07
Apr
Jul
Oct
Jan 08
Apr
Jul
Oct
Jan 09
Apr
Jul
Oct
Jan 10
Apr
Jul
Oct
Jan 11
Apr
Jul
Oct
Jan 12
Apr
Jul
Oct
Jan 13
Apr
Jul
Oct
Jan 14
Apr

0.00

-2.00
Source: Data from BoM Monthly Statistical Bulletin.

Interbank rates have been known to fluctuate outside of policy rate corridors for several reasons.
Interbank rates may be higher than the rate at which governments purchase securities if a bank
wants to avoid the stigma of going to the central bank for overnight funds. Doing so may portray
the commercial bank as risky, and may make it more difficult to obtain overnight interbank loans
in the future.
More oftenas is the case in Mauritiusinterbank rates drop below the rate of return on
government securities. There are several possible causes for this phenomenon, although it is
most commonly associated with excess liquidity in the banking sector. If all banks hold excess
reserves and there is little demand for interbank loans, then the interbank rate will drop below the
interest rate on government securities. Excess liquidity can be either structural or cyclical:
cyclical excess liquidity is a result of large capital inflows through avenues such as foreign direct
investment, while structural excess liquidity is a result of a lack of investment opportunities in
the domestic market.
Graph 3 shows the buildup of excess liquidity in Mauritius since 2007. Excess liquidity peaked
in March 2011 with over 12,590 million rupees of surplus reserves in the banking sector, and
after an initial drop in response to the government issuing short-term securities5, has been
climbing again. While the buildup of these excess reserves certainly has an effect on monetary
policy, there are two pieces of evidence that support the hypothesis that excess liquidity is not
the only breach in the Mauritian monetary system.
5

Central governments frequently respond to excess liquidity in the system by either increasing reserve ratios or
selling short-term securities to sterilize excess reserves. The sale of short-term government securities to commercial
banks is referred to as mopping up excess liquidity.

(1) If excess liquidity is the only cause


of a declining interbank rate we would
14000
Excess Liquidity
expect to see a strong correlation
12000
between the amount of excess liquidity
10000
in the system and the gap between the
policy rate and the interbank rate.
8000
Graph 4, however, depicts little to no
6000
linear correlation between these two
4000
indicators. The gap remains high
2000
throughout 2007 despite relatively low
levels of excess liquidity during this
0
period, fluctuates from 2008 to 2014,
and declines beginning in 2014 despite
increasing levels of excess liquidity.
Source: Data from BoM Monthly Statistical Bulletin.
The lack of linear correlation between
the two variables does not mean that excess liquidity is not pulling down interbank rates, but it
does suggest that there are other variables at play.
Jan 07
Jul
Jan 08
Jul
Jan 09
Jul
Jan 10
Jul
Jan 11
Jul
Jan 12
Jul
Jan 13
Jul
Jan 14

Graph 3: Excess Liquidity

(2) Mauritiuss historical experience with monetary policy also hints at other problems involving
the transmission mechanism. Mauritius contended with ineffective policy rate pass-through
under both the bank rate and the Lombard rate, despite very low levels of excess liquidity in the
system. Graph 5 depicts the low correlation between the Lombard rate and the interbank rate
from 2003 to 2007, where there was less than 2,500 million rupees over the federal reserve
requirement.

6
4

10000

2
5000

0
-2

0
Jan 07
Apr
Jul
Oct
Jan 08
Apr
Jul
Oct
Jan 09
Apr
Jul
Oct
Jan 10
Apr
Jul
Oct
Jan 11
Apr
Jul
Oct
Jan 12
Apr
Jul
Oct
Jan 13
Apr
Jul
Oct
Jan 14
Apr

(Rs millions)

Graph 4: Excess Liquidity and the Gap between the KRR and Interbank Rate
15000
Excess Liquidity
Gap (KRR - Interbank)

Source: Data from BoM Monthly Statistical Bulletin.

(%)

Graph 5: Correlation between the Lombard and Interbank Rate


2500.00

Excess Liquidity (Mil Ru)

Interbank Rate

14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00

Lombard Rate

(Rs millions)

2000.00
1500.00
1000.00
500.00
Nov

Sep

Jul

May

Mar

Jan 06

Nov

Sep

Jul

May

Mar

Jan 05

Nov

Sep

Jul

May

Mar

Jan 04

Nov

Sep

Jul

May

Mar

Jan 03

0.00

Source: Data from BoM Statistical Bulletin.

These two facts combined suggest that there are other breaches in the monetary policy
transmission mechanism. The rest of this report will explore possible explanations of for the
failed transmission mechanism and evaluate the likelihood of each transgression.
III. Transmission Mechanism Failures
A. Review of Possible Transmission Mechanism Failures
As the previous section demonstrated, monetary policy pass-through is a complex, multi-step
process that relies on several underlying assumptions. As Mishra, Montiel, and Spilimbergo
(2010) argue in a working paper for the IMF, these underlying assumptions are not always valid
for low-income or middle-income economies. Traditional monetary policy transmission assumes
the following institutional background:

A large and diverse formal financial sector where financial intermediation is protected
through a strong regulatory framework
An independent central bank
A highly developed and highly liquid secondary market for government securities
A highly developed and highly liquid interbank market for overnight loans
A floating exchange rate
A competitive banking sector6

Emerging economies rarely satisfy most or all of these conditions. Out of the preceding
assumptions, Mauritius enjoys a large formal financial sector, and independent central bank, and
a floating exchange rate. This leaves the most likely breaches in Mauritian monetary policy as
the result of i) An underdeveloped secondary market for government securities ii) An
underdeveloped interbank market or iii) Imperfect competition in the banking sector. The rest of
this section will elaborate on each assumption and explain its pertinence to effective monetary
6

Montiel, Spilimbergo & Mishra, (2010)

(%)

policy. Available data will then be analyzed concerning each condition to determine how
applicable the assumption is to the Mauritian case.
B. Evaluation of Transmission Mechanism Failures
Underdeveloped Secondary Market for Government Securities
A large part of the pass-through from policy rates to interbank lending rates is dependent on a
well-developed secondary market for government securities. Governments typically hold
periodic primary auctions of government securities when they need to raise money and these
securities are assumed to be purchased by secondary playerscommercial banks, other financial
intermediaries, or the nonbank public. These secondary players then trade different types of
securities (i.e. government, financial, corporate, short-term or long-term) in a well-developed
secondary market such as a stock exchange. In modern monetary policy central banks conduct
the sale and purchase of short-term securities in these secondary markets.
An underdeveloped (or nonexistent) secondary market for government securities leads to two
primary problems in the conduct of monetary policy. The first problem is a time lag between
policy rate and interbank rate pass-through. The lower bound of the policy rate corridor depends
on an arbitrage taking place between the interbank rate and the rate of return on short-term
securities7. The interbank rate and the rate of return on government securities should move
toward one another as securities are rolled over between commercial banks and other secondary
players until banks are at a point of indifference between holding securities or holding reserves.
Without competitive and highly liquid secondary markets this arbitrage cannot efficiently take
place, leading to a time lag in policy rate pass-through.
The second problem involves the buildup of involuntary excess liquidity. When banks hold
excess reserves they are assumed to use these reserves to expand lending (either to the interbank
market or nonbank public) or purchase securities for a higher rate of return. In the case where
opportunities for lending are low and there is an underdeveloped secondary market for securities
banks may be able to earn a higher rate of return on reserve deposits than they can through
remunerative alternatives8.
These considerations lead us to ask how developed are secondary markets in Mauritius? Table 1
provides some insight into the question. Table 1 displays the outstanding stock of domestic debt
securities by country and sector of issue as well as the ratio of outstanding stock of domestic debt
securities to GDP. Mauritius has the lowest outstanding stock of domestic securities across
sectors at 4.9 billion USDin part owing to its small sizebut a relatively high stock to GDP
ratio at 0. 411. For comparison with other upper middle-income countries Peru has a ratio of
0.126, Turkey of 0.251, and South Africa of 0.566.
7
8

Montiel, Spilimbergo & Mishra, (2010)


Saxegaard, (2006)

Table 1: Domestic Debt Securities by Sector of Issue


Stock (USD billion) 2013

Stock to GDP 2013

Stock to GDP mean 2010 - 2012

Financial Corporate
Financial Corporate
Financial
Country
Total
Government
Sector
Sector
Total Government Sector
Sector
Total Government Sector
Argentina
14.7
14.7
0.024
0.024
0.031
0.031
Australia
1255.2
499.6
709.0
46.7
0.804
0.320
0.454
0.030
0.967
0.334
0.599
Brazil
2000.5
1275.1
577.1
148.3
0.891
0.568
0.257
0.066
0.913
0.601
0.256
Canada
1689.5
1147.3
333.8
208.5
0.926
0.629
0.183
0.114
0.893
0.623
0.168
China
4084.7
1504.0
1762.3
818.4
0.442
0.163
0.191
0.089
0.478
0.162
0.223
Chile
133.5
33.0
69.8
30.8
0.482
0.119
0.252
0.111
0.485
0.104
0.243
Colombia
95.0
92.6
2.4
0.251
0.245
0.006
0.245
0.240
Hungary
96.7
63.8
32.5
0.3
0.767
0.506
0.258
0.002
0.588
0.394
0.189
India
634.8
634.8
0.338
0.338
0.212
0.212
Indonesia
101.4
81.7
12.7
7.0
0.117
0.094
0.015
0.008
0.167
0.132
0.027
Israel
217.1
138.5
30.8
47.8
0.745
0.475
0.106
0.164
0.781
0.455
0.156
Japan
12041.2
9015.2
2390.9
635.1
2.457
1.839
0.488
0.130
2.550
1.836
0.565
Korea
1406.3
459.4
394.5
552.4
1.078
0.352
0.302
0.423
0.976
0.313
0.306
Malaysia
333.7
150.8
60.1
122.9
1.068
0.483
0.192
0.393
1.077
0.456
0.239
9
Mauritius
4.9
4.90
0.004
0.005
0.411
0.410
0.000
0.000
0.413
0.413
0.000
Mexico
606.1
386.3
172.5
47.3
0.481
0.306
0.137
0.038
0.414
0.248
0.133
Peru
25.4
12.8
9.6
3.0
0.126
0.063
0.047
0.015
0.160
0.066
0.069
Philippines
89.5
86.4
3.0
0.329
0.318
0.011
0.322
0.308
0.000
Russia
284.6
126.3
75.0
83.3
0.136
0.060
0.036
0.040
0.118
0.056
0.025
Saudi Arabia
20.0
20.0
0.027
0.027
0.058
0.058
Singapore
98.6
98.6
0.331
0.331
0.410
0.410
South Africa
198.6
131.4
41.6
25.6
0.566
0.375
0.119
0.073
0.545
0.343
0.128
Switzerland
218.3
114.7
85.9
17.7
0.335
0.176
0.132
0.027
0.328
0.181
0.118
Thailand
264.9
93.9
123.6
47.4
0.684
0.242
0.319
0.122
0.800
0.262
0.416
Turkey
205.6
188.7
15.1
1.8
0.251
0.230
0.018
0.002
0.290
0.280
0.010
Source: Data from BIS, Stock of Domestic Debt Securities by Residence and Sector of Isssue. Country GDP from World Bank World Development Indicators.

Corporate
Sector
0.035
0.056
0.103
0.093
0.137
0.006
0.005
0.008
0.170
0.149
0.357
0.382
0.000
0.033
0.026
0.014
0.038
0.073
0.028
0.123
0.000

Domestic debt security data for Mauritius was not available from the BIS. Data for government securities was gathered from the Bank of Mauritius monthly
statistical bulletin and data for financial and corporate securities was provided by the Stock Exchange of Mauritius. Financial and corporate securities data for
Mauritius is not available for 2010.

However, a closer look reveals that the central government issues almost the entirety of
Mauritian debt securities. Financial and corporate securities make up a negligible fraction of the
total stock,10 suggesting an underdeveloped secondary market for securities. Further
investigation into the Stock Exchange of Mauritius reveals that there are only four major
companies issuing debenture11 and two out of the countrys twenty-one commercial banks. In
addition, government securities are primarily traded through the Secondary Market Cell of the
Bank of Mauritius rather than through the Stock Exchange of Mauritius. These factors indicate a
low level of secondary market development in the country with adverse effects on monetary
policy.
Underdeveloped Interbank Market
Interbank markets play a pivotal role in the conduct of monetary policy and the functioning of
the banking system. A well-developed and highly liquid interbank market gives commercial
banks access to overnight loans when they are short of funds, promoting greater stability and
flexibility in the financial sector. Assumed to be a standard feature in OECD countries, interbank
markets may not be as highly developed in low-income or middle-income economies.
Sacerdoti (2005) finds case study evidence that interbank markets are underdeveloped in SubSaharan Africa. A poor regulatory environment and high cost of evaluating risk can lead to
mutual distrust among banks and dissuade them from lending to one another. The effect of
underdeveloped interbank markets on monetary policy transmission is debilitatingwithout a
functioning interbank market banks are more prone to build up excess liquidity (especially in the
frequently simultaneous case of an underdeveloped secondary securities market) and the central
bank has no way of enforcing the lower bound of the policy rate corridor.
Unfortunately, no comprehensive dataset or standard indicators exist to evaluate interbank
market development. Ideally we would examine the frequency, number, and volume of various
countries interbank loans and compare these values after adjusting for country GDP. Such
analysis would require access to detailed interbank transaction data and the application of a
Furfine-based algorithm12 to identify overnight interbank loans; however, this information is
generally confidential and not available to the public.

10

The figures for financial securities in Mauritius may be slightly lower than reality as data for the outstanding stock
of Bank of Mauritius securities was unavailable for analysis.
11
Data is from the Stock Exchange of Mauritius and does not include small to medium size enterprises.
12
Central banks commonly use Furfine-based algorithms to identify the overnight interbank lending rate. Furfinebased algorithms identify overnight interbank loans by searching interbank transaction data for a transaction of
volume x made on day t (the initial loan) and a transaction of volume x + r where r is some range of possible
interbank interest rates on day t + 1 (the repayment of the initial loan) between the same market players. Furfine
algorithms have been shown to be generally accurate in identifying interbank loanssee Akram & Christophersen
(2013).

Instead, Graph 6 shows the annual volume of interbank loans in Mauritius. Growth has been
steady over the past decadewhich is consistent with expectations for a developing marketin
comparison to the relatively constant and then declining interbank loan volumes of a developed
economy such as the US, which graph 7 depicts for comparison.
Graph 7: Volume of Interbank Loans in the US

Graph 6: Volume of Interbank Loans in Mauritius

25,000

200000

Interbank Loans
20,000

2 per. Mov. Avg. (Interbank Loans)

150000

15,000
100000
10,000
50000

5,000

0
1995

2000

2005

2010

Source: Data from BoM Monthly Statistical Bulletin.

2015

Yearly Avg of Interbank Loans (US


bil)

0
1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Data from St. Louis Federal Reserve

While it is not possible to draw a conclusion on Mauritian interbank market development without
more comprehensive data, it seems unlikely that underdeveloped interbank markets explain the
breach in monetary policy. The countrys strong regulatory framework and increasing volume of
interbank loans suggest a functioning interbank market.
Imperfect Competition
An important and often overlooked condition for effective monetary policy is the existence of a
competitive banking sector. Effective arbitrage between policy rates and interbank rates as well
as arbitrage between interbank rates and lending rates is dependent upon competition, yet
imperfect competition often exists in low-income and middle-income countries. The weaker
regulatory environment, lack of alternative nonbank financial institutions, and historical
importance of state-run banks all contribute to these conditions.13 Mauritius also faces an
inherent challenge in terms of market size due to its nature as a small island economy.
Imperfect competition in the banking sector can affect the conduct of monetary policy in two
primary channels. 1) Akram and Christophersen (2010) and Allen et al. (2012) find that
systematically important banks14 are able to obtain lower overnight loan rates in the Norwegian
13

Saxegaard, M. (2006).
Systematically important banks are defined as large, and well-connected banks that play an active role in the
interbank market and enjoy a sizable domestic market share.
14

and Canadian interbank markets, respectively. This phenomenon was attributed to a too big to
fail effect after the recent financial crises but the implications of these findings for monetary
policy are far-reaching. In the case of imperfect competition, systematically important banks may
be able to use their market power to obtain more favorable lending rates and pull down the
average interbank rate in the process.
2) Mishra, Montiel, and Spilimbergo (2010) explain the effects of imperfect competition for the
pass-through from interbank lending rates to short-term interest rates. Under textbook economic
conditions, banks should pass on the reduced cost of interbank loans to lower lending rates as
they compete to attract customers. However, banks that wield considerable market power may
purposefully restrict lending with the result that changes in the interbank rate only affect bank
profit margins. These conditions may also lead to a buildup of excess liquidity in the system if
banks hold excess reserves rather than use them to lend on the interbank market or purchase
securities (see previous sections).
Several proxy measures exist for measuring competition in the banking industry. The
Herfindahl-Hirschman Index (HHI) measures concentration within an industry by summing the
squares of the 50 largest firms market shares15. The index ranges from 0 to 10,000, with 0
indicating perfect competition and 10,000 indicating perfect concentration (a monopoly). The
Mauritian Bankers Association reported an HHI score for total assets of 1,078 in 2012 for the
Mauritian banking sector. Figure 1 displays total asset market share among Mauritian banks in
2013. An HHI index of 1,078 places Mauritius in the moderate band of market concentration,
although it is likely that domestic market concentration is much higher. Market share is usually
calculated as domestic deposit share rather than total assets since foreign deposits can skew
concentration numbers. This is especially relevant to the Mauritian case where a large number of
banks are foreign-owned subsidiaries. Unfortunately, domestic deposit share data is not currently
available to the public so it is difficult to draw conclusions on the true level of concentration in
the domestic banking industry.

15

The HHI index is used by the United States Department of Justice when evaluating the impact of mergers and
acquisitions in the domestic market.

Figure 1: Mauritian Banking Sector Total Asset Market Share 2013 (%)
0.71

3.07
3.21

1.72
1.81
0.02

21.05
11.31

1.48
2.48

10.82

15.66
9.94
7.06

3.59
0.13

4.05
1.72

0.19

ABC Bank Corporation Ltd


AfrAsia Bank Limited
Bank of Baroda
Bank One Limited
Banque des Mascareignes Ltee
Barclays Bank Mauritius Limited
Bramer Banking Corporation Ltd.
Century Banking Corporation Ltd.
Deutsche Bank (Mauritius) Limited
Habib Bank Limited
HSBC Bank (Mauritius) Limited
Investec Bank (Mauritius) Limited
Mauritius Post and Cooperative Bank Ltd.
P.T. Bank International Indonesia
SBI (Mauritius) Limited
Standard Bank (Mauritius) Limited
Standard Charted Bank (Mauritius) Limited
State Bank of Mauritius Ltd.
The Mauritius Commercial Bank Ltd.

Source: Data from Mauritian Bankers Association Profile of Banks 2014.

It is important to note that concentration alone does not necessarily indicate imperfect
competition. The two measures are generally correlated, but a new school of thought argues that
concentration in the banking sector actually strengthens stability in the financial system.16As
such, we need to employ another proxy measure to evaluate the degree of imperfect competition
in the Mauritian banking sector. Bank profit margins can be such an indicator. In a noncompetitive industry we would expect to see firms reporting large profit marginsmeasured in
the banking sector through large net interest margins or interest rate spreads17. Table 2 reports
both the net interest margin and interest rate spread of a sampling of countries. Mauritius reports
a moderate net interest margin of 2.99 in 2011, and a slightly higher interest rate spread of 4.89
in 2012. For comparison, other upper middle income countries such as Venezuela, South Africa,
and Malaysia report net interest margins and interest rate spreads of 7.40, 1.87; 2.76, 3.31; and
2.29, 8.89 respectively.

16

See Bheenick, R. (2010, August).


Net Interest Margin is defined as (Interest Received - Interest Paid) / Average Invested Assets and the Interest
Rate Spread is defined as (Lending Rates Deposit Rates). See Demirg-Kunt & Huizinga (1998) for further
information on the correlation between concentration and large net interest margins in the banking sector .
17

Table 2: Profitability Measures of Banks


Interest Rate Spread
Country
2012
Mean 2000 - 2011
Argentina
2.04
5.40
Australia
3.06
4.26
Brazil
28.73
37.54
Canada
2.52
3.30
China
3.00
3.31
Chile
4.27
4.03
Colombia
7.23
7.12
Hungary
3.72
2.38
Indonesia
5.85
5.41
Israel
3.35
3.63
Japan
0.93
1.45
Korea
1.70
1.65
Malaysia
1.81
3.14
18
Mauritius
4.89
4.73
3.65
Mexico
5.16
Peru
16.78
19.21
Philippines
2.52
4.24
Russia
3.57
8.15
Singapore
5.24
4.77
Seychelles
8.89
7.02
South Africa
3.31
4.22
Thailand
4.30
4.44
Ukraine
5.43
11.34
Venezuela
1.87
5.83
Source: World Bank World Development Indicators.

Net Interest Margin


2011
Mean 2000 - 2010
7.00
3.27
2.06
2.09
4.97
6.44
3.23
2.13
2.74
2.47
3.56
5.10
5.08
3.31
4.29
6.32
5.41
1.40
2.36
1.01
1.23
2.65
2.39
2.60
3.25
2.99
3.24
2.92
5.93
5.94
6.32
3.65
3.99
3.93
4.79
1.52
1.78
2.29
4.03
2.76
4.05
2.94
2.79
6.15
6.73
7.40
9.84

Overall Mauritius only reports moderate indicators of imperfect competition in the banking
sector. However, it is impossible to draw definitive conclusions without access to bank domestic
deposit shares or detailed transaction data on loans in the interbank market.

IV. Conclusion
This report explored the efficacy of the current monetary policy framework in Mauritius.
Monetary policy is essential for combatting inflation and promoting price stability in emerging
economies, yet monetary policy transmission in these environments faces significant challenges.
We found that the pass-through between policy rates and interbank lending ratesthe first step
in the four primary transmission channelsis impaired in Mauritius. Interbank lending rates
remain consistently below the lower bound of the policy rate corridor. This phenomenon has
been attributed to the buildup of excess liquidity in Mauritius but a low level of correlation
between the amount of excess liquidity in the system and the gap between policy and interbank
rates leads us to believe that there are other transmission failures.

18

Interest Rate Spread data for Mauritius is calculated from data from the Bank of Mauritius as (Weighted Average
Rupee Lending Rate Weighted Average Rupee Deposit Rate).

The second part of this report explored three explanations for these transmission failuresan
underdeveloped secondary securities market, an underdeveloped interbank market, and imperfect
competition in the banking sector. We found evidence of an underdeveloped secondary market in
Mauritius, possibly leading to large time lags in monetary policy and the buildup of excess
liquidity. Little data was available to evaluate the development of the Mauritian interbank
market, but there is a lack of a priori evidence for an underdeveloped market with Mauritiuss
strong regulatory framework. Some indicators were found for imperfect competition in the
banking sectorwhich can also lead to artificially low interbank rates and the buildup of excess
liquiditybut it is impossible to draw definitive conclusions with the current data gaps.
As such, the recommendations for this report primarily involve improvements in data collection
and reporting. Mauritius should closely monitor the development of secondary securities markets
and report annual figures according to BIS guidelines in order to create an accurate development
record. In addition, the Bank of Mauritius or authorized independent researchers should analyze
interbank transaction data to evaluate the nature of the overnight interbank market. Particular
areas of research interest include the distribution of excess reserves in the banking sector and
whether systematically important banks receive more favorable lending rates. Finally, the
Competition Committee of Mauritius should compile data on domestic deposit market share
among banks in order to examine concentration and competition within the banking industry.

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