IV Credit Inflation and the Reform of the Monetary Union, 1974

Rattan Bhatia
Published Date:
May 1985
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As observed earlier, between 1963 and 1974 the deposits of commercial banks increased faster than their demand for rediscountable credit. This, coupled with the BCEAO’s readiness to provide liberal rediscount facilities, enabled the banks to expand their own lending resources, especially for nonrediscountable credit. But between 1965 and 1974 commercial banks in the Union held more rediscounted credit than the liquidity ratio prescribed—on average about 5 percent of total deposits, compared with an average cash ratio of about 4 percent. One reason that not all the increase in deposits was lent as rediscountable credit may have been insufficient demand; alternatively, some banks may have felt that rediscount ceilings would have a restrictive impact on their operations.8

However, given the rationale for the BCEAO’s overall ceilings, the rapid growth of time deposits, and the fixed low interest rates on rediscountable credit, the banks did attempt to maximize their profits by using their deposit resources to lend almost the full permissible amount of nonrediscountable credit—reducing the ratio of rediscountable credit to total credit (see Table 6, and Bhatia and Basu, 1975). In the entire BCEAO area, outstanding rediscounts declined as a proportion of the outstanding total credit to the private sector, from 66 percent in 1967 to 52 percent in 1974. (Senegal was the main exception to this trend; its ratio increased from 46 percent to 71 percent, presumably reflecting the depletion of bank liquidity as a result of deficits in the balance of payments.) With this decline in the ratio of rediscounts to total credit (a mirror image of the growth in time deposits noted earlier), the ability of the BCEAO to influence overall credit through its rediscount policy was weakened. This was dramatized by the upswing in bank credit in 1974.

The Credit Inflation of 1974

In 1974 total credit to the private sector increased by CFAF 92.4 billion or by 48 percent over the previous year, even though rediscounts (annual quarterly averages) from the Central Bank increased by CFAF 44.4 billion. The increase in total rediscountable credit (credit actually rediscounted with the Central Bank plus other rediscountable credit retained in the portfolio of commercial banks) accounted for only about half the increase in credit to the private sector.

This raises two questions: first, how such a large increase in credit was financed, and second, whether the Central Bank could have restrained it significantly with the instruments then at its disposal. The first question may be analyzed by looking at various components of the credit multiplier, m (note that this is not the money multiplier), which defines the relationship between net domestic liabilities of the Central Bank or the net resource base, Ba, and the level of credit, CR:

CR = m · Ba


where k, t, and d are, respectively, the ratios of currency, time deposits and treasury deposits to demand deposits, and r and b represent, respectively, the ratios of cash balances of banks and borrowing from the Central Bank to total bank deposits. The base is defined as the sum of currency and the public and cash reserves of commercial banks, less claims of the Central Bank on commercial banks (approximating net domestic liabilities). With a given base, the ability of commercial banks to expand credit is affected positively by an increase in b (the borrowing ratio), and I (the lime deposit ratio), and negatively affected by an increase in r (the cash reserve ratio) and in k (the currency ratio).

The behavior of these ratios and the credit multiplier over time for the area as a whole is shown in Table 13 in the Statistical Appendix. The overall credit multiplier (four-quarterly averages), which had fluctuated by around 5 during the period 1962–72, jumped more than threefold to 18.3 in 1974, largely as a result of the increases in t and in b, accompanied by a decline in k. Thus, with an unchanged base, commercial banks would have been able to increase credit almost threefold. However, the base declined simultaneously from a quarterly average of CFAF 39 billion in 1973 to CFAF 19 billion in 1974. Since the change in total credit is due to the change in the base (ΔCR1) plus the change due to the credit multiplier (for small changes in m and Ba):

The change in total credit attributable to the changes in the two components are also shown in Table 13 in the Statistical Appendix. It will be noted that the relative importance of the change in the money multiplier became significant after 1971, but dominated only in 1974. In that year, the change in the multiplier increased credit by about CFAF 230 billion, while the reduction in the base lowered credit expansion by CFAF 120 billion.9

It should be noted that changes in the variables k, t, b, and r, all influencing the change in m, depend upon the portfolio decisions of the private sector and of the commercial banks. (Since the BCEAO passively accommodated demand for rediscounts, b is assumed to reflect bank preferences.) Of these variables, the behavior of k and t may be taken as exogenous for the purposes of central bank policy: although they could also be influenced by policy action, the outcome would always be uncertain. An increase in the interest rate on deposits, for example, would shift balances from both currency and demand deposits into time deposits.

Moreover, in 1974, a significant shift in these ratios would probably have required substantial changes in the interest rate structure which, in view of institutional rigidities and the adjustment in interest rates made in early 1973, the monetary authorities would have found practically impossible to undertake. The value of J is also exogenous, set by budgetary policy, subject to the statutory constraint mentioned earlier. Accordingly, an assessment of the potency of monetary policy must focus on the ability of the Central Bank to control the banks’ borrowing ratio or the cash reserve ratio.

The borrowing ratio, defined as the ratio of rediscounts to total deposits, could be affected by the Central Bank’s adjusting access to its rediscount window (by changing ceilings), or by increasing the liquidity coefficient. However, given the relatively low (preferential) interest rates on rediscountable loans, a reduction in the rediscount ceiling in the context of BCEAO policy would have fallen essentially on rediscountable credit—-and this would have been contrary to the intentions and policy stance of the BCEAO. In fact, the commercial banks’ total recourse to the Central Bank increased by 75 percent (nearly CFAF 60 billion) in 1974. This apparently left changes in the liquidity ratio as the other policy option.

The effect of varying the liquidity ratio, Q, may be illustrated as follows:

QDD + (Q − 1)RD = R + RDC = TBR

(Recalling that R is cash reserves, RD is rediscounts with the Central Bank, RDC is rediscountable credit in the portfolio of commercial banks, DD is demand deposits, and TBR is total bank reserves.) From this equation it can be shown that for any given level of deposits and rediscounts:

R = Q(DD + RD) − RDCRD

According to these relations, the absolute level of required reserves will increase by an amount equal to the percentage point increase in Q multiplied by the short-term liabilities of the commercial banks (including rediscounts from the Central Bank). In 1974, the quarterly average of such liabilities for the area as a whole was CFAF 245 billion, while the actual liquidity ratio was 0.78. Thus, a 1 percentage point increase in the liquidity ratio would have forced an increase in cash reserves of CFAF 2.5 billion (or nearly 22 percent of the actual level of reserves). For individual member countries, the increase in cash reserves would have varied between 5 percent (Togo) and 26 percent (Ivory Coast). Such a large and disparate increase in reserves could not have been enforced without causing severe problems for individual banks. Furthermore, given the level of total rediscountable credit, which amounted to CFAF 175 billion in 1974, even such a large reserve increase would have reduced the rate of increase in credit by only about 1 percentage point in that year. Thus, the liquidity ratio, as defined by the old statutes, could not have succeeded in moderating significantly the rate of increase in domestic credit.

The 1974 Reform

The WAMU was reformed in October 1974 to strengthen the role of monetary policy, particularly in economic development and integration. The BCEAO was provided with a wider range of policy instruments, including a new tool for controlling credit expansion, domestic and international interest rates were harmonized, an interbank money market was established to be managed by the BCEAO, and limits were set on the ratio of liquid assets lo minimum working balances that the banks could hold outside the Union, The participation of WAMU members in the decision-making process, relative to that of France, was also increased.

Under the old statutes, France played a predominant role in decision making within the BCEAO. Under the revised statutes, France has the same representation as each member country, namely two directors on the Board, and most decisions are taken on the basis of a simple majority. In the past, when France represented one half of the Board’s membership, decisions required a two-thirds majority. However. France continues to stand ready to support the free convertibility of the CFA franc into the French franc. But there is a subtle difference between France’s old and new responsibilities: under the old system, France guaranteed convertibility: now it merely agrees to support WAMU to maintain that convertibility. However, in practice, this difference may be only semantic. The support is to be provided mainly in the form of overdraft facilities through the operations account which the BCEAO maintains with the French Treasury. In return, the BCEAO is required to deposit at least 65 percent of its foreign currency reserves in French francs in the operations account: France provides an exchange guarantee for those deposits in terms of the SDR. The exchange rate of the CFA franc vis-à-vis the French franc remains unchanged, and all members of the WAMU continue to belong to the French franc zone and align their exchange policy with France. France, of course, continues to provide bilateral, and in some cases budgetary, assistance to the WAMU countries. The headquarters of the BCEAO was also moved from Paris to Dakar.

The revised WAMU treaty explicitly recognized that a monetary union between the member countries was essential to the promotion of rapid development and harmonization of their economies. A West African Development Bank was created, with half of its initial capital of CFAF 2.4 billion provided by the BCEAO and the rest by the member states. The development role of the BCEAO was further emphasized by changes in the rules governing its lending to member governments. To give further weight to the WAMU institutions, the supreme authority of the Union was vested in the Conference of the Heads of State. Otherwise, the institutional structure remained unchanged as far as the BCEAO was concerned, with the Council of Ministers at the apex of its direction and the Board of Directors and the National Credit Committees being responsible for the conduct of day-to-day policy.

The new statutes, and the rules of intervention associated with them, equipped the BCEAO with a range of policy instruments to control both the quantity and the sectoral distribution of credit in member countries. A major departure from the pre-1974 regime was the abolition of the distinction between redisxsxssssxscountable and nonrediscountable credit, and the consequent revision of the liquidity-ratio requirement. The new statutes strengthen the monetary policy instruments available for the control of domestic liquidity and ensure greater flexibility in their application at the national level. The main instruments in their revised garb are described below.

Quantitative Control

Rediscount Facilities

The rediscount facilities continue to be the principal means of central bank control over liquidity in member countries. The BCEAO is required to set annual targets for total central bank financing in each member state, taking into account production, prices, liquidity, and the balance of payments target, as well as the level of external reserves of each country and the total external reserves of the area as a whole. (The statutes still require the BCEAO to act, should its level of external reserves fall below 20 percent of its sight liabilities.) The annual limits on central bank financing exclude seasonal credit for financing crops and their export; it is considered difficult to estimate such requirements in advance and such financing is, in principle, expected to be repaid during the year. However, the BCEAO is expected to supervise such credit strictly lo ensure that it is not used for other purposes.

While limits on central bank financing are fixed for each country, the earlier ceilings on individual banks have been abolished. The National Credit Committees can now allocate credit as they deem fit. However, the rules still prescribe a maximum limit (45 percent) on the ratio of a bank’s total credit that may be rediscounted with the BCEAO.

Unlike under the earlier statutes, the limits on the Central Bank’s financing under the new rules include credit extended to governments. As mentioned earlier, the limit on credit to governments was raised from 15 percent to 20 percent of the previous year’s fiscal receipts. Moreover, the BCEAO is now authorized to accept government obligations of up to 10 years’ maturity for purposes of financing development projects, including infrastructure. While the overall financing limits are decided by the Board of Directors, the suballocatiion of the limit between the government and financial institutions is left to the National Credit Committees. However, a government’s right to obtain credit is limited by the statutes only, and within these limits its request for credit cannot be denied. Thus, the residual financing available to the financial institutions within the global ceiling fluctuates inversely with the requirements of the national treasuries. To this limited extent, therefore, fiscal policy is coordinated with the overall monetary policy.

Reserve Requirements

As mentioned above, with the eradication of the distinction between rediscountable and nonrediscountable credit, the old requirement of the liquidity ratio was abolished. The new rules, however, empower the BCEAO to impose reserve requirements on commercial banks, expressed either as a percentage of their deposits or of credit extended by them. Such a requirement is considered useful when banks’ deposits increase rapidly, whether due to seasonal or external factors such as an export boom or an exceptional inflow of foreign funds.

To ensure the liquidity of banks, the BCEAO is also authorized to impose a coefficient de trésorerie, establishing a minimum ratio between a bank’s short-term liquid assets and its sight liabilities. In addition, the banks are subject to a coefficient de division des risques, which prescribes a maximum ratio between nonguaranteed loans to a single enterprise and the banks’ own (capital plus reserves) resources.


The national banking legislation passed by each member country in the context of the 1974 reform envisages, among other requirements for the provision of information, a system of penalties on banks not observing the BCEAO’s credit rules. Notably, such penalties may take the form of non-interest-bearing deposits with the Central Bank.

Rediscount Rate

The new rules envisage an active role for interest rate policy. The Governor of the BCEAO is authorized to vary interest rates, taking into account both the domestic and international money market conditions. (Interest rates had already risen in 1973.)

Qualitative Control

The new rules also provide the BCEAO with a variety of instruments to influence the sectoral distribution of credit.

Prior Authorization

The banks are required to obtain prior authorization from the Central Bank for all credit beyond a certain limit (CFAF 100 million for Ivory Coast, CFAF 70 million for Senegal, and CFAF 30 million for other countries) to any single enterprise. This authority for prior authorization is vested in the National Credit Committees. While its ostensible purpose is to affect the distribution of credit, it is also a potential instrument for influencing the overall credit expansion.

Preferential Interest Rates and Lending Coefficients

With the authorization to vary interest rates came the simultaneous authorization for the BCEAO to give preferential rates for certain credits (seasonal credit, loans to small and medium-size national enterprises, and small loans for housing construction). The Central Bank can also impose certain minimum lending ratios to ensure credit for national enterprises.

One of the objectives of these new statutes is to decentralize decision making on credit expansion, so that each member can pursue an individual credit policy, within the global requirements of the Union. The newly created National Credit Committees in each member country are similar to the National Monetary Committees under the previous statutes; the Chairman of each Committee, the Minister of Finance, continues to propose to the Board of Directors of the BCEAO the total amount of credit to be extended, but for a twelve-month rather than a six-month period as under the previous statutes. The Board decides on the ceiling, taking into account current local economic conditions and the overall policy objectives of the WAMU. Under the old statutes, a considerable degree of latitude was given to the National Credit Committees in determining the use and distribution of credit, and specific rediscount ceilings were prescribed for individual enterprises, suggesting an automatic right of access to rediscounting facilities. Under the new statutes, while an overall rediscount ceiling for the country is retained, specific ceilings for banks and particular enterprises are abolished.

In addition to having greater power in deciding the sectors to which rediscount facilities should be offered, the BCEAO can influence the distribution of credit by providing rediscount facilities at preferential rates for certain specific activities, responding to the requirements of seasonal farming, small and medium-size national enterprises, and small-scale construction. This was partly a result of the new move away from the pre-1974 cheap money policy of the BCEAO, Moreover, the BCEAO is empowered to direct banks to allocate a certain proportion of their working capital to finance certain national enterprises. The new statutes also authorize the BCEAO to impose reserve requirements to control credit expansion when the banks may find themselves to be excessively liquid. The BCEAO retains the power to require commercial banks to maintain deposits with the BCEAO; the liquidity ratio, which had proved ineffective in controlling the expansion of credit by the banking system, is abolished under the new statutes.

One major change from the previous system is that the overall credit ceiling for a member country affects both the private and the government sectors. Thus, the private sector has access only to the balance of credit remaining after the requirements of the government have been met, subject of course to the limit on credit extended to the government sector. However, as in the previous system, the 20 percent limit, though covering only the credit from the banking system, includes in practice borrowing from virtually all domestic sources, since there is no way to tap the nonbank sector. This naturally keeps the option of borrowing from foreign sources open to governments.

Another key objective of the new statutes is to foster investment in capital within the region. Three main ways are proposed: an interest rate policy more in line with international market rates (the basic rediscount rate was initially increased to 8 percent); an interbank money market managed by the BCEAO, established to channel funds from one country to another: and, to avoid any leakages, a limit on the liquid assets that banks and financial institutions are permitted to maintain abroad.

The concern with external sector developments is no more explicit in the new statutes than it had been under the old statutes, as is evident from the requirement that decisions regarding general credit conditions should be taken by unanimous vote whenever the foreign reserves of the BCEAO fall to an average of less than 20 percent of the Bank’s short-term liabilities for more than three consecutive months.

The new statutes also recognize the need for increased fiscal coordination. First, the Board of Directors of the BCEAO, acting on the request of each country’s National Credit Committee, can allocate credit annually to each country, keeping the WAMU’s “overall policy objectives” in mind. This necessarily liberal criterion has the potential to be used more intensively as the economics of the Union are further integrated. Second, as already mentioned, a West African Development Bank has been set up to assist the development of the region with an initial funding of CFAF 2.4 billion. (Compare this figure with the BCEAO’s total short-term credit of CFAF 257.33 billion to the private sector in 1974.) Third, while a ceiling exists on government borrowing from its country’s credit allocation from the BCEAO, a government cannot be denied credit up to its limit. Hence, the financing available to financial institutions varies inversely with the amount a government will decide to borrow, up to its limit. A modicum of integration of fiscal policy within overall monetary objectives is, therefore, assured.

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