When Rwanda's central bank reduced its key repo rate by a half of a percentage point to 7 percent in June, the financial market anticipated banks to pick the signal and lower interest rates on commercial loans.
But three months later, that decision has yielded only a miserly 0.2 per cent reduction in commercial bank lending rates, a change that some financial analysts are even reluctant to attribute to the fall in the central banks' key lending rate.
And recently, the National Bank of Rwanda (BNR)'s Monetary Policy Committee (MPC) decided to maintain the repo (the fiscal tool it uses to mop up excess liquidity from the market) unchanged at 7 per cent to the surprise of some who anticipated a further reduction as an attempt to coerce lending rates down and encourage more borrowing by the private sector.
A further reduction, some argued, would perhaps force down interest rates on commercial loans that the private sector says still remain relatively high at 17.5 per cent given the fact that the rate of inflation is significantly low at about 4 per cent.
In keeping the repo unchanged, the financial sector regulator argues that there is ample rise in supply of credit to the private sector which, although less than the previous year, is enough to support economic growth.
Figures show that new approved loans to the private sector during the first quarter of the year amounted Rwf97 billion, Rwf122 billion in the second quarter and are projected to top Rwf110 billion in the third quarter--that is a 7.6 per cent rise at the end of August.
"We think that there is good financing from the private sector for the performance of the economy," said BNR governor, John Rwangombwa. But is the increase in loans an indication that the borrowers are comfortable with the price they pay for the credit?
"Not at all, because there are no options," said a businessman who preferred anonymity. Rwangombwa is optimistic that even without further reduction in the repo rate, interest on commercial loans will come down, albeit gradually.
"When we took the decision to lower our key repo rate in June that immediately had an impact on the money markets... [as] the treasury bill rate reduced from 12 to 7 per cent. Even interbank lending rate reduced from 11 to 7.6 per cent--these are signs that the decision we took in June to allow more funding to the private sector is already [yielding results]," the governor said, soon after chairing the MPC meeting that made the decision.
Upon further probing he added: "We haven't seen big impact in terms of reduction in lending rates yet, but this usually happens with the time lag ... we expect to see this happen."
The real determining factor not to lower the repo rate for the next quarter however appears to have been driven by fear of inflation that crept to 4 per cent lately on account of seasonal increase in food prices.
Lowering the repo rate would most likely result in more credit to the private sector--that would in turn mean more cash chasing after scarce food and other goods. Not only might this cause inflationary pressure, but it could also add to the current depreciation pressure against the Rwanda Franc.
"[In order] to avoid more inflationary pressures and to avoid pushing deposit rates to real negative rates, we thought that it was important that we maintained the key repo rate at 7 per cent," Rwangombwa said.
Commercial banks in Rwanda lately have suffered a decline in customer deposits (the amount of money kept by individuals and companies) when the government borrowed heavily from the domestic market through treasury bills to fund development projects in the wake of delays and cuts in donor budget support.
During that period, would-be depositors preferred to invest money in government paper in the processes starving banks of deposits, the cheapest source of working capital. That means even with fears about inflation, it was prudent to maintain the rate as an increase would make treasury bill rates lucrative once again.
In its recent assessment of the performance of banks in East Africa, Renaissance Capital, a leading investment banking firm, says the problem of low deposits cuts across the entire banking sector in Rwanda. This is attributed to low penetration of banking services that has left many Rwandans keeping their money under mattresses at home.
Sound finance sector
Meanwhile, BNR's Finance Stability Committee (FSC) has given the banking sector a clean new bill of health, declaring it well performing and stable even as the ratio of non-performing loans leaped unexpectedly to 7 percent. The central bank had targeted further reduction in the number of bad loans to at least 5 per cent, but woke up to a rude shock when several bank-funded projects went bad.
"There is continued soundness in our financial sector though there was slight increase in NPL--it is not worrying at 6.9[per cent]. We are confident that by the end of December, we shall have hit out target of 5 per cent NPL," Rwangomba said.
He bases his optimism on the recent meting with the officials of the concerned banks who he said had indicated the situation is reversible.
"It is also possible to reverse the trend after looking at the "few projects that are causing the NPL ratio to go up," he added.
Bank portfolios are good, profitability is increasing and assets continue to grow, the governor noted.
For example, the capital adequacy ratio is at 23 per cent, which the central bank says is above the regulatory minimum of 15 per cent. The banks, according to BNR, also remain well capitalized with liquidity rate of 46.2 per cent as of June 2013, against the mandatory 20 per cent.
BNR attributes the current stability in the sector to a "strong regulatory framework in place coupled with adequate supervision through continuous off-site and on-site inspections performed by BNR as well as regular prudential meetings."
The soundness of the banking sector will however be seen in the way it was reverse the embarrassing occurrence of non-performing loans that only a year ago looked completely under control.