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Why did the National Bank of Kazakhstan raise the refinancing rate?

On April Fools' Day, the central bank of Kazakhstan got wise to a game played by commercial banks.  

The National Bank raised the interest rate that it charges private banks on loans, from 5.5% to 11% per year. This sounds draconian, which was probably the commercial banks’ view of the matter. But it was vital to the Bank’s modernization of monetary policy. I’ll explain.

In the West, most central banks manage the money supply, and consequently affect the economy, by manipulating the interest rate. Lower interest rates encourage firms to finance expansions with cheap loans; households also expand economic activity.

To cut interest rates, central banks create money. They buy securities in exchange for dollars and euros, which security sellers put into their bank accounts. In turn, banks lend these deposits out, lowering their interest rates to attract borrowers.  If you prefer, you can think about this monetary policy more directly: By purchasing bonds, the central bank raises bond prices. This lowers their rate of return, which is the interest rate.

Which interest rate do central banks target? The short-run rate, since they want to affect the economy quickly. In the United States, the Federal Reserve operates on the interest rate that commercial banks charge one another on overnight loans, called the federal funds rate.

The counterpart in Kazakhstan is the base rate, which is 11%. And now you see the problem. Commercial banks have little reason to borrow from anyone at 11% when they can go to the discount window (jargon for borrowing from the central bank) and load up on tenge for 5.5%, which has been the going rate at the window since 2012. So when the National Bank cut the base rate, as it did in February, it may not have elicited as much response from the economy as was possible, because the commercial banks weren’t borrowing as much as they could have at that rate, anyway.

The solution was to raise the refinancing rate (the Bank’s term for the rate at the discount window) to the base rate. That’s what the National Bank did on April 1. And, as the Bank notes, the refinancing rate “is used in civil law and administrative-legal relations for charging penalties, indemnification fines and in computation of the lost profits,” so it makes sense to ensure that it reflects the true cost of holding or earmarking money.

The Bank’s new policy does incur a few costs. One purpose of the discount window is to provide cheap bailouts to troubled banks, since bank failures imperil the financial market. Emergency loans are more expensive now. On the other hand, cheap bailouts tempt banks to take dangerous risks, not an unknown occurrence in Kazakhstan.

Things could have been worse: In the hyperinflationary days of 1995, the refinancing rate was 152% on a one-month loan.   --Leon Taylor tayloralmaty@gmail.com

Good reading

Jane E. Ihrig, Ellen E. Meade, and Gretchen C. Weinbach.  Rewriting Monetary Policy 101: What's the Fed's preferred post-crisis approach to raising interest rates?  Journal of Economic Perspectives. Fall 2015.

References

National Bank of Kazakhstan. On convergence of the official refinancing rate and the base rate. Press release. www.nationalbank.kz March 6, 2017.

National Bank of Kazakhstan.  Statistics.  www.nationalbank.kz. May 7, 2017.