What the CBN’s Monetary Policy Committee does and how it affects you


 

Often times, we wonder what the Monetary Policy Committee (MPC) does, who makes up the committee, and how the outcome of its quarterly economic review meetings affect you. We will address these questions in this short article.

The Monetary Policy Committee (MPC) of the Central Bank of Nigeria (CBN) is made up of 12 members of which the CBN Governor is the Chairman. The committee’s mandate is to facilitate the attainment of macro economic objectives such as economic growth, price stability (which includes inflation, interest rates and exchange rates) and providing economic policy support to the Government. In fulfilling these objectives, the committee meets quarterly to formulate monetary and credit policy.

Here is how their deliberations affect you and I 

The Monetary Policy Rate (MPR)

MPR is the interest rate at which CBN lends to the commercial banks. The MPR is the benchmark against which other lending rates in the economy are pegged and is usually used as an instrument to moderate inflation in the economy.

An adjustment in this economic parameter by the MPC could either positively or negatively affect an individual through its effect on the prime lending rate (i.e. cost of borrowing). The prime lending rate is the interest rate at which a commercial bank lends to its most credit-worthy borrowers (usually large corporations, because their risk of default is quite low).

Not every customer obtains loans at the prime rate. Most customers are only able to obtain loans at a rate higher than the prime rate mostly because they are more likely to default on a loan. An increase in the Monetary Policy Rate by the MPC will result in an increase in the price (interest rate) you pay for borrowing and vice versa. That is, an increase in MPR results in a rise in the prime lending rate, and other lending rates by commercial banks, to the public.

The Monetary Policy Rate is currently held at 14%. It was last increased in 2016 from 12% to 14% – a 2% change. This implies that there would also be a 2% increase in prime lending rate in the economy. Your bank most likely responded to this hike by jacking up their lending rate as well. The consequence of this is that the average Nigerian would have had to pay about 2% more to borrow from the bank.

The aim of this policy move is to discourage you from borrowing, so that you would hold less cash to spend or invest in the economy. This will help to reduce the level of inflation in the economy, since inflation is fuelled by high levels of cash in the economy.

The Cash Reserve Ratio (CRR)

This is another key economic parameter that the MPC would likely adjust or hold in their next meeting depending on the various underlining macroeconomic variables.

CRR simply refers to the ratio of customer deposits (i.e. your money in the bank) the bank is expected to hold as cash or keep with the CBN. The CRR is meant to alter the amount of deposits banks can deploy for lending. So basically, the higher the CRR, the less money banks have available to lend to you and I.

Through this policy lever, the CBN manipulates the flow of cash around the economy. A higher CRR implies banks will be left with less money to lend or to invest, while, on the other hand, a cut in CRR means banks will be left with more money to lend or to invest. Through this, more money can be released into the economy. This policy may spur economic growth if appropriately utilized.

This policy is also meant to control the level of spending in the economy, and by extension, the level of inflation. The last time this was reviewed was last year when it was raised to 22.5% from 20% in a move aimed at tightening liquidity.

Currently, the CRR as set in the last MPR meeting is at 22.5%, meaning that banks must hold in their reserves N225 out of every N1000 deposit.

Liquidity Ratio

Liquidity ratio refers to the amount of highly liquid assets that banks should hold in order to meet their financial obligations to you, their customer.

As a depositor, banks are mandated to give you your withdrawal whenever you show up at their teller desk. This ratio is designed to guarantee that this keeps happening. Liquid assets include cash and near cash assets.

If the MPC reviews liquidity ratio upward, more fund will be available to you for withdrawal. In other words, this particular parameter ensures that your bank always hold enough cash to pay you on demand.

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