EFFECTS OF MONETARY POLICY RATE ON INTEREST RATE AND LEVEL OF CUSTOMER BORROWING

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ABSTRACT

The study sought to investigate the effects of monetary policy rate on interest rate and level of customer borrowing in the banking industry with evidence GCB Bank from 2013-2017. The study outlined some specific objectives such as; to assess the effects of Bank of Ghana’s Monetary Policy Rate on lending rate of GCB Bank and to assess the effects of lending rate on the level of customer borrowing at the GCB Bank. The study also measured the impact of external factors such as inflation rates and GDP growth rate on the banking sector.

The study adopted the quantitative approach to research. The study used descriptive and cross- sectional designs. The data was sampled from financial statements of GCB bank, the BoG fact file and Ghana statistics Service for the period under review. A regression analysis (Ordinary Least Square Method) was conducted to test the effects, relationship and significance of the level of customer borrowing, lending rates and policy rates. Results were mainly presented in charts and tables. The study found a strong effects and significant association between BoG’s policy rate and GCB bank lending rates at P<0.05. Also lending rates have a negative influence on the level of customer borrowing. Inflation rates have a negative influence on client borrowing. This project concludes that monetary policy rate and lending rate can affect level of customer borrowing.

CHAPTER ONE

INTRODUCTION

        : Background of the study

Monetary policy has been defined by (Gertler & Gilchrist, 1993) as monetary tools used by the Central Bank of a country to achieve its set objective of regulating liquidity or interest rate. According to (Abor, 2004), commercial banks serve as intermediaries between customers and the central bank by borrowing at the prevailing policy rate and in turn lending it to individuals and organizations.

The central Bank (BoG) Monetary policy has undergone some transition; over the past decades from the earlier times of direct monetary controls to the time where monetary policy operates under a liberalized environment. Not until 1983, where the central bank worked with direct controlled monetary system, this period involved mainly a dependence on direct monetary support instruments which imposed ceiling on commercial bank’s lending. The commercial banks’ interest rate had to be in line with the central bank’s macroeconomic targets (Khandkar, 1995).

There was an urgent need for the direct control system to be replaced with the current liberalized monetary system, since the direct control system proved to be ineffectsive. The central bank (BoG) uses indirect instruments such as the Prime rate as a tool for guaranteeing solidity of the economy during the implementation of the liberalization system. (Kwakye, 2012).

According to (Diamond, 1984), Individual customers and businesses rely on commercial banks to finance projects that their saving is not enough to support. Regardless of the fact that other options are available to these customers, majority of them still rely on bank loan as their principal source of credit to fund their projects. Loans from banks attract interest because the banks also borrow

from the central bank. What this simply means is that as the central bank’s prime rate goes higher, the higher the financial institutions’ loan rate and vice versa.

Monetary policy rate means the borrowing rate of which financial institutions borrows from the apex bank (BoG). The BoG’s monetary policy rate serves as control mechanism for setting the interest rates of other markets like wholesale rate (interbank rate and Treasury bill rate) and retail rate (deposit rate and lending rate). The determination of the short term interest rate is made by the Monetary Policy Committee of the central bank from which various commercial banks and other financial institutions also operate with. The interest rate of commercial banks is therefore invariably determined by the BoG’s monetary policy rate. Beyond that, other economic activities in the country are affected by the policy rate that is determined by the Monetary Policy committee. (De Gregorio& Sturzenegger, 1997).

Gertler and Gilchrist (1994) opined that economic activities in a country are impacted by the decisions about the monetary policy committee’s short term interest rate. The effects normally occurs through several channels like the exchange rate channel, interest rate channel etc. which is collectively known as “transmission mechanism”.