Bhutan readies to sharpen ‘blunt’ policy instruments

The Royal Monetary Authority of Bhutan is considering introducing short-term lending and deposit windows to replace its system of "sweeping overnight balances", a report released by the International Monetary Fund on June 30 has revealed.

Staff at the IMF describe some of the central bank's existing tools as "rather blunt" – singling out the cash reserve ratio (CRR) and the statutory liquidity ratio (SLR). The authorities explicitly agree with regard to the CRR. Further tools, staff say, could strengthen the monetary transmission mechanism.

But the authorities point to preconditions to the change. According to the report, they feel "while the Royal Monetary Authority (RMA) is ready to deploy new monetary policy instruments, for the successful development of the interbank market, short-term instruments to be used as collateral are required, including banks' certificate of deposits and short-term government securities".

The authorities also note a "proper legal framework" is needed to allow both creditors and debtors to understand their rights and obligations under the new framework.

Base rate system

Bhutan has operated with a base rate system since 2012. The base rate is the minimum at which a bank can lend. Staff note this takes into account the cost of funds, cost of complying with certain regulations – such as CRR or SLR – overhead costs and profitability.

According to the staff report, the authorities acknowledge "widespread dissatisfaction" with the current system, including calls "to come up with a fairer system of interest rate setting". The RMA is already envisaging a review of the base rate system, the authorities say, possibly introducing a single base rate.

Staff at the fund also note the current system "hampers" monetary transmission, with the policy of reviewing base rates annually "essentially imposing one-year-lagged monetary conditions on the next year's base rate".

"The lack of uniformity in the application of the base rate methodology, prompted by the practice of ad hoc adjustments to reduce variation of the base rates across banks and financial institutions, has led to inefficiencies and hampered transparency," staff say in the report.

Staff at the fund support the view monetary management in the country needs to be strengthened, suggesting a number of other tools that "could help to improve monetary transmission".

The RMA could, they note, adopt similar features to the Reserve Bank of India, which has implemented a marginal cost of funds-based lending rate. It has limited the funding costs used in its calculation to more recently raised funds, assigned these funds a greater weight and stipulated monthly-based reviews.

"Monetary policy transmission would become more effective, as the transition from the policy rate to interbank rates and government securities rate, and from the interbank rates to bank deposit and lending rates, would strengthen," IMF staff say.