Central Bank says restrictions on Standing Facility windows aimed at easing interest rates

• Excessive dependence by certain commercial banks on Standing Facility windows observed
• Says such behaviour affects Central Bank’s ability to reactivate interbank market 
• Notes that Standing facilities are fall back options after using all other funding options 
• Interest rates stay stubbornly high despite relative easing in inflation

The Central Bank releasing a statement during the weekend said the measures announced earlier in the week to impose certain restrictions on commercial banks’ access to its Standing Facility windows were aimed at inducing a moderation in market interest rates by reactivating the interbank money market as such actions will improve market liquidity conditions. 
It in recent times has expressed unease at the stubbornly high interest rates which it believes are excessively high compared to the key policy rates standing at 14.5 percent and 15.5 percent. 

The Central Bank has warned that if banks bring down the rates by themselves, it would intervene in the interbank market and also would be compelled to take certain administrative measures to bring the rates down. 
It has identified the subdued or near inactivity observed in the last few months in the interbank market as one of the reasons for the rates to stay higher at the current levels without showing any capitulation even when the inflation turned a corner in October.

Although still remaining at red-hot levels, inflation measured by the Colombo Consumer Price Index eased for the third consecutive month in December to 57.2 percent from a peak of just under 70 percent in September. But the interest rates haven’t budged at all.  
As a result, the Central Bank with the intention of reactivating the interbank market last week announced measures to restrict the licensed commercial banks’ access to the Standing Deposit Facility (SDF) to five times a month while limiting the access to the Standing Lending Facility (SLF) to a maximum of 90 percent of a bank’s reserve requirement at any given day, effective from January 16.  

Through these measures the Central Bank expects banks to start transacting among themselves for their liquidity needs and reduce overreliance on its Standing Facilities.
“These measures would also eliminate unhealthy competition for deposits among financial institutions and would be instrumental in inducing a moderation in the market interest rate structure (of both deposit and lending interest rates) in the period ahead along with improving market liquidity conditions, which will help to restore stability of the Sri Lankan economy, while preserving stability of the financial system,” the Central Bank statement said.

The Central Bank further said it had observed that several commercial banks had continued to depend excessively on the overnight Standing Facilities under open market operations without considering market-based funding options to address their structural liquidity needs. 
“Such LCBs have not indicated any signs of taking remedial actions to reduce the over dependence on overnight facilities offered by the Central Bank, which are available to be used as fall back options after utilising all other funding options,”the statement said. 

“Such behaviour of LCBs affects the efforts of the Central Bank to reactivate the money markets, primarily the interbank call money market and the repo market, while posing a threat to smooth channeling of funds in the economy with a possibility of clogging the payment and settlement systems,” it added.