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INTEREST RATES & THE ROLE OF A CENTRAL BANK (DETERMINANTS OF INTEREST…
INTEREST RATES & THE ROLE OF A CENTRAL BANK
INTEREST RATE
Return on capital
Price of money
For the lender, it is the amount of funds received when they extend credit
For the borrower, it is a cost of borrowing
[NOMINAL VS REAL INTEREST RATE]
Nominal Interest Rate (i)
No allowance for inflation - ignores the effects of inflation
Rate of interest that is accrued at some time in the future
Real Interest Rate (r)
Rate of interest at some time in future after discounting the rate of inflation
Reflects the true cost of borrowing
Formula
i = r + where
i = nominal interest rate
r = real interest rate
pai e = expected inflaction
DETERMINANTS OF INTEREST RATE
Inflation
As inflation rate is expected to increase, HH who have excess of funds may reduce savings to make more purchases before prices increase
HH willing to borrow more funds in order to purchase more products now before prices increase
Put upward pressure on interest rate
Economic Growth
Businesses increase their planned expenditures for expansion (lead to additional borrowing) - upward pressure on interest rate
Economic slowdown put downward pressure on interest
Foreign flows of funds
Interest rate may change due to massive flows of funds by large investors who want to seek high return on investment
Investors normally attempt to invest their funds in debt securities especially in countries that have HIGH interest rate & stable currency
Money supply (MS)
When CB increases MS, money available for loans increase. Interest rate will reduce
If CB reduces MS, money available for loans reduce - give upward pressure on interest rate.
Budget Deficits
Budget deficit = govt expenditure > govt revenues
If budget deficit is high, demand for loans by the government will increase - interest rate will increase
Excessive demand for loans by the government will lead to "crowding-out" effect
RESERVES OF BANK NEGARA MALAYSIA + COMPONENTS & ITS CURRENCY SAFEGUARDING ROLE
Support & maintain confidence in the policies for monetary & exchange rate management
Provide level of confidence to markets that a cuntry is able to meet its externall obligations
Demonstrate backing of domestic currency by using external assets
Assist the gornment in meeting its foreign exchange needs & external debt obligations
Maintain a reseve for national disasters or emergencies
RELATIONSHIP BETWEEN INTERBANK RATES, OPR, REFERENCE RATE & LENDING RATES
INTERBANK RATE
Rate of interest charged on short-term loans made between banks.
OVERNIGHT POLICY RATE (OPR)
Interest rate in which a depository institution lends immediately available funds (balances within the CB) to another depository institution OVERNIGHT
OPR is determined by BNM in the Monetary Policy Committee Meeting held throughout the year
REFERENCE RATE
Interest rate benchmark, which is used to set other interest rates
LENDING RATE
Interest rate charged by a financial institution for lending money
Refer appendix for more details on Malaysia's effective lending rate
The more from BLR to BR does not affect the effective lending rate
RELATIONSHIP BETWEEN OPR, REFERENCE RATE (BR) & LENDING RATE
If OPR changes, it will directly influence reference rate (base rate)
Base rate will be revised
Increase in OPR means the bank will increase the reference rate (BR)
BR increases - effective lending rate will increase
Increase the loan/ financing payment or repayment
[BANK NEGARA MALAYSIA: OBJECTIVES, FUNCTIONS & MONETARY INSTRUMENTS]
OBJECTIVES
Promote monetary stability & a sound financial structure
If inflation is too high
More demand on real assets like houses & properties - but less demand on other productive investment for the economy
Savers are less inclined to hold savings in the financial system since they expect the value of saving will diminish
Fixed income earners experience a reduction in their standard of living
Exports become more expensive - reduce Malaysia's competitiveness
Reduce potential growth of the economy
Act as a banker & financial adviser to the government
Give regular advice on the management on the management of its domestic & external debts
BNM as agent for the government in negotiations & concluding loan agreements
Issue currency & keep reserves safeguarding the value of the currency
Reserves are held in the form of Gold, Reserves position in the International Monetary Fund (IMF), Special Drawing Rights (SDR) and Portfolio of foreign exchange assets denominated in major international currencies in the form of bank balances, treasury bills, long term securities
Influence credit situation to the advantage of the country
Act a banker to other banks
FUNCTIONS
Prudent conduct of monetary policy
Maintaining low & stable inflation
Preserving the purchasing power of MYR
Ensure stability in financial system
Able to meet sophisticated needs of consumers & businesses
Develop financial system infrastructure
Building nations's efficient & secured payment system
Building necessary institutions to ensure comprehensive & resilient financial system (e.g : Bursa Malaysia, CGC)
Promote financial inclusion
Improve access to financial services for all economic sectors
Issues currency & safeguarding its value
Provide advise advise to the government on macroeconomic policies & public debt management
MONETARY INSTRUMENTS
Statutory reserve requirement
All banks are required to place certain amount of cash reserve with BNM
For liquidity management
Discount rate
rate of interest BNM charge on loans to financial institutions
Open market operations
Sales & purchase of government securities
Affects rate that can be offered to depositors
Help in influencing level of saving
Moral Suasion (qualitative instrument)
Informally induce a positive voluntary response from the financial system to BNM policy initiatives