Business Comment: Insufficient liquidity in banking can halt investment growth

Total volume of excess liquidity in the banking sector has been expanding in the past. This always forced the National Bank of Rwanda (BNR) to withdraw this amount from circulation using its monetary operations. However, recent developments have shown that the liquidity position in the banking sector has tightened, with the central bank reporting this week that excess liquidity observed in 2007 has been declining over 2008. The central bank says that liquidity in the banking system has been diminishing over the year 2008 as a consequence of a significant improvement in the absorption capacity of the economy. In its monetary policy and financial stability statement, BNR also said that interest rates in money markets took an upward trend since the last quarter of 2008, saying that the inter bank rate moved from 6.97 percent in September 2008 to 7.74 percent in December 2008. These trends have prompted BNR to announce monetary policy measures aimed at increasing private sector’s access to credit in order to meet their growing demand of investment capital. The measures announced include slashing the reserve requirement ratio by three percent to five percent. BNR has also said it will not rollout all the short term government securities maturing this year. Insufficient liquidity in the banking sector may increase the banks’ inability to timely meet obligations when they fall due without incurring unacceptable losses. This being critical, banks’ management must make sure that sufficient funds are available at a reasonable cost to meet potential demand from borrowers. The declining liquidity has also surfaced through funding costs, requests for collateral by the lending institutions, decreases in credit lines as-well-as reductions in the availability of long-term funding. With government stressing that Rwanda’s economy is likely to be affected by the global financial recession through decline in commodity prices and demand slowdown in Foreign Direct Investment (FDI), decline in None Government Organisation’s (NGO) transmission transfers and remittances from Rwandans in diaspora. It has been noted that there is also a possible decline in official transfers. And yet the capital market is still developing, Rwanda’s banking sector plays a larger role of providing investors with liquidity. Creating of enough liquidity in banking is crucial to locally generate enough resources for financing physical investments. Contact: gahamanyi1@gmail.com