At the end of last month, the National Bank of Slovakia (NBS) tightened its monetary policy, increasing the repo rate - a short-term loan rate for commercial banks - by a total of 0.7 percentage points in two stages and adding over 1 percentage point to the return rates for its treasury bills. While the increases may seem small, they signal that the Bank wants to keep inflation in check.
The NBS is worried that as commercial bank business picks up, the "M2" money supply has been growing too fast. The Bank wants to limit the annual growth rate to around 11 percent, but the amount of M2 money in circulation grew at an annual rate of 21.2 percent in April; by May, it jumped to 22.8 percent.
"The NBS decided to raise the rates based on unwanted developments in the M2," said NBS spokesman Ján Onda. "The M2 is doing poorly and is much higher than we had expected."
"The NBS has observed significant growth [in the M2]," said Jean Christophe Ganz, the director of ING Bank Slovakia, "which if not handled could lead to inflationary pressure and a possible overheating of the economy." With more and more money in circulation, there is more and more money to be spent, which could result in demand outstripping supply, including an increase in the current boom in purchases of imported products.
Moreover, an increased return on the NBS's t-bills make the treasury bonds more desirable, which will "dry up funds," Ganz said. The higher repo rate helps the situation in another way by making it less attractive for banks to lend. When a commercial bank needs cash quickly, it can sell some of its paper assets - for example, bonds such as those attained from privatization - to the National Bank.
The NBS, acting as a secondary purchaser, will then hold onto the papers for a certain period of time; before the time is up, the commercial bank can buy back its assets for the original price plus the repo rate, which the NBS raised 0.7 percentage points from 7.0 to 7.7 percent on June 27.(The reverse repo rate, the figure at which the NBS sells to commercial banks, also rose 0.7 percentage points from 6.0 to 6.7 percent on the same day.)
Soaring BRIBOR
This tinkering with the repo rate caused shockwaves on the commercial lending market. The three-month Bratislava Inter Bank Options Rate (BRIBOR), the standard lending rate between commercial banks and a stable indicator of banking trends, skyrocketed nearly 3 percentage points within a week.
Prior to that, the BRIBOR hit its highest level since it opened last year, when it shot from 9 percent at the end of May to 12.5 percent in the first week of June. While changes in the short term rates governed by the BRIBOR don't mean much to conservative banks that match their assets and liabilities, commercial banks that make their money by playing the rate market could get hurt.
For example, a bank borrowing money at a 3-month rate of 9.5 percent and sinking it into 5-year bonds with a 13 percent rate stands to make a lot of money. But if the 3-month rate suddenly jumps to 13 percent, the deal could be disastrous for the borrowing bank.
While the BRIBOR rise seems drastic, the result of an uncurbed money market is much scarier to Bratislava's commercial bankers, who can use the Czech Republic as a model of what could happen. The Czech National Bank, facing a similar M2 situation at a further stage of development, has had to raise interest rates even higher and introduce credit ceilings on the amount commercial banks could lend.
To avoid this, the NBS "has tried to strongly recommended that the commercial banks slow down the pace of the growth of their portfolios," said Ganz. "They also indirectly called on certain large providers [such as Slovenská Sporiteľňa, the Slovak Savings Bank] to reduce the amount of money on the inter-bank market."
Even if Slovakia's banks keep a tighter grip on their money, consumers may not see too much of a difference. "Generally, repo rates don't really drive the market," said Susan Ballinger, a consultant for the Slovak Banking and Business Advisory Center (SBBAC) in Bratislava.
"In my experience banks here are very slow to respond to changes at a consumer level - it's not like in the U.S. where there is a jump one day and the banks react," Ballinger added. In fact, the rise in 3-month rates on the BRIBOR has subsided, drifting back to around 11.5 percent. The NBS has no plans to up its repo rates anytime soon, said Onda, but "the future will tell."
