In its meeting on Thursday, the CBE unexpectedly issued a decision to fix the interest rate at 11.25% for deposits and 12.25% for lending, in addition to 11.75% for the basic transaction price, for one day.
This decision was accompanied by another unexpected decision, which is to raise the mandatory reserve ratio from banks to the CBE to 18% instead of 14%. This poses the question about the meaning of this decision, its purpose, and how it will affect the economy.
The mandatory reserve is a percentage of banks’ deposits in EGP, with the exception of certificate deposits for a period of 3 years or more, which banks are obliged to keep in the CBE without receiving interest on them.
The CBE uses this type of policy to control the amount of liquidity in the market, and through it drive inflation closer to the target rate.
Example: If the average bank deposits were EGP 10 million, and the mandatory reserve ratio is 18%, the bank is supposed to deposit EGP 1.8 million in the CBE without receiving any interest.
Effect on Economy
By increasing the mandatory reserve ratio, the CBE will aim to reduce the volume of liquidity in the economy, by reducing the amount of money that banks can lend, also known as the money supply.
According to Asharq, this step aims to reduce the money supply by EGP 140-150 billion.
The main objective of reducing the money supply is to control inflation, because the amount of liquidity that can be borrowed from banks will decrease, and thus the rate of demand for goods and services will decrease.
Effect on Banks
The decision has a negative impact on the banks because they are now obliged to deposit a larger reserve in the CBE without a return, instead of lending out this liquidity and profiting from interest, and thus the bank’s profitability decreases.
But banks still have the possibility to compensate for this difference, by raising the cost of borrowing from them, which means that the liquidity that they will lend to customers will have a higher interest rate or, on the other hand, reduce the interest which the bank will bear on deposits.
The CBE said in its statement that fixing the current interest rate in addition to raising the mandatory reserve for banks will contribute to achieving price stability, and keeping the inflation rate between 5%-9%, the inflation level the CBE targets.