Building Monetary and Financial Systems

Chapter 1. Building the National Bank of Rwanda’s Monetary and Supervisory Functions

International Monetary Fund
Published Date:
October 2007
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Gillian Nkhata

Following the 1994 genocide, Rwanda’s economy and its financial sector all but collapsed. The Rwandese government was quick to embark on far-reaching reforms, which have resulted in sustained high growth, with Gross Domestic Product (GDP) rising each year between 0.9 and 13.8 percent between 1996 and 2005, despite continuing instability in the sub-region. This chapter will focus on how the National Bank of Rwanda (BNR) has nurtured this recovery, from post-conflict stabilization to reconstruction, while transforming itself into an effective central bank, through persistent efforts to upgrade capacity. The chapter will highlight the wide range of reforms undertaken by the BNR, including the overhaul of monetary policy, the refining of monetary policy instruments, its internal reorganization, and the strengthening of the regulatory and supervision framework for banking. The BNR–the main regulator and supervisor of the financial sector–has managed to restore all its core functions, but still faces formidable challenges, including the shallowness of the financial sector, a shortage of human capital, and inadequate institutional, legal, and judicial frameworks.

Serious Social Deterioration and Macroeconomic Imbalances in the Immediate Aftermath of the Genocide

Following decades of ethnic tensions, peppered with episodes of armed confrontations, Rwanda’s political situation disintegrated into a civil war in the early 1990s. In 1994, the conflicts culminated in a massive genocide, with devastating consequences for the small, densely populated, landlocked country. An estimated 800,000 to one million people, out of a total population of 7.9 million, lost their lives, while over 2 million fled into exile. Another one million were displaced internally, ending up in camps in the southwest of the country. The country’s administrative system collapsed, and many institutions, including the central bank, closed. Public services were cut back to a bare minimum.

The economic fallout was overwhelming. GDP dropped to an estimated half of its level in the previous year, with manufacturing and construction sectors producing only half of their pre-conflict levels. Cash crop farms were abandoned by their owners and, in many cases, transformed into subsistence farms, with disastrous consequences given the country’s heavy dependence on coffee and tea export proceeds. Export volumes dropped by 60 percent, while import volumes rose by nearly 30 percent. Large humanitarian aid inflows, amounting to over 140 percent of GDP in 1994, combined with output shortages to put pressure on demand and consumer price inflation, which picked up sharply from 12 percent in 1993 to 64 percent at end-1994. In the prevailing context of administered interest rates, real interest rates became strongly negative. International reserves dropped to less than two months of imports.

Redressing Post-Conflict Macroeconomic Imbalances and Launching Much-Needed Structural Reforms

In July 1994, after the conflict, a new transitional government was formed, comprising representatives of all political parties, except for that of the former government. The design was based on the power-sharing priorities agreed under the 1993 Arusha peace agreement.1

There were a number of pressing issues on the agenda. First, the government needed to work quickly to reestablish social order and suppress still latent tensions. Refugees needed to be repatriated, displaced persons had to be resettled, ex-combatants needed to be demobilized. A comprehensive national reconciliation strategy was needed, which covered not only assistance to refugees, displaced persons, and other people hurt by the war, but also restoration of internal security and reinforcement of the justice system.

Equally urgent was the need to rebuild the productive capacity–a gargantuan task given the post–genocide realities. Most businesses had lost virtually all of their equipment, supplies, and records, while buildings and other assets were severely damaged. Qualified workers had lost their lives or fled. The government also needed to rapidly restore the capacity for economic management, regain macroeconomic stability, and initiate key structural reforms. It immediately embarked on a comprehensive recovery plan, embracing not only an economic agenda, but also capacity and institution building, and measures for the demobilization of ex-combatants, the resolution of charges against the genocide-accused and the establishment of a permanent political framework. By end-1994, many ministries, the central bank, two commercial banks, and over 1,500 primary schools had reopened, though with greatly reduced staff. Around one million of those that had left the country earlier in the year and during previous conflicts had also returned.

From Emergency Assistance to Reconstruction (1995–2004)

Over the following decade, Rwanda continued to make remarkable progress on both economic and social fronts, with the support of the international community, including the IMF. The production of food crops improved significantly in 1995, mainly owing to favorable weather conditions. By 1996, about 60 percent of the industrial enterprises had resumed operations. Some basic social and physical infrastructure had been restored, while key economic institutions, such as the central bank and the Ministry of Finance and Economic Planning, had been largely rehabilitated. Many of the internally displaced persons and returning refugees had been resettled.

As for GDP growth, following the initial rebound of 35 percent in 1995, it remained at an average of 13 percent a year over the next two years, driven mainly by the recovery in subsistence agriculture and construction. The annual rate of inflation (as measured by the consumer price index for Kigali) fell from about 64 percent in 1994 to 9 percent in 1996. Gross international reserves recovered to about four months of imports in 1997, mainly because of financial support from donors, concessional borrowing for balance of payments support, and the partial recovery of the export base. By 1998, real per capita GDP surpassed its prewar level for the first time. The focus of the government’s policy was now shifting from emergency and humanitarian issues to rehabilitation and development.

To strengthen the recovery, the government also took bold steps to liberalize the economy. Recognizing the much reduced scope for government participation in productive activities, it immediately set out to create an economic environment that was conducive to the development of the private sector. It removed price controls, liberalized domestic marketing, and reduced tariffs on imports (quantitative restrictions had been eliminated in 1992). It liberalized the coffee sector, authorizing competition from collection through to exporting, adopted a new tariff code, with fewer rates, and lowered the maximum rate from 100 percent to 25 percent over the period 1995–99. The export surrender requirement for coffee and tea was reduced in stages and eliminated by end-1997.

In the monetary and financial areas, the most significant changes were the introduction of a market-determined exchange rate and the liberalization of interest rates, the reconstruction of the central bank, the revival of the commercial banking sector, the strengthening of the regulatory and supervisory environment, and the modernization of the payments system. The IMF provided intensive technical assistance to the BNR’s efforts in these areas.

Monetary and Exchange Reforms

On March 6, 1995, the BNR adopted a more flexible exchange system, which could be characterized as a managed float, with no predetermined path for the exchange rate. The BNR ceased to announce official exchange rates for the Rwanda franc, and commercial banks were free to set the exchange rate for the Rwanda franc against foreign currencies. The BNR limited its role to the daily calculation and publication of an average market exchange rate applied in transactions, for reference purposes. In addition, residents were free to acquire foreign exchange through commercial banks and exchange bureaus, and to make payments abroad for all current international transactions. For nonresidents, a change was the ability to transfer abroad the proceeds received from their international transactions, while exporters were allowed to sell their foreign export earnings freely on the domestic foreign exchange market, or to retain them in accounts with domestic banks. Seven exchange bureaus were licensed during the first day of operation of the new system.

The adoption of the flexible exchange rate regime in Rwanda was achieved expeditiously and with limited ensuing instability in the exchange rate. However, the BNR was faced with new risks for monetary management. Right before the introduction of the new exchange rate regime, reserve money had increased substantially, with banks’ free reserves at very high levels. Large amounts of foreign aid were flowing into the country, and there were few profitable lending opportunities for the banks. The BNR did not have adequate instruments to sterilize the excess reserves held by the banks, while the Ministry of Finance had insufficient revenues to pay interest on its debt. Arrears on outstanding government obligations were making it difficult to issue Treasury Bills (T-Bills) for monetary policy purposes, and the BNR’s financial situation too was weak, ruling out the use of central bank bills or remunerated deposits as monetary instruments. The BNR was therefore left with having to work with its existing instruments, which at the time comprised interest rate regulations, reserve requirements, and refinance instruments.2

In order to continue the downward pressure on inflation, the liberalization of the exchange system and introduction of closer control over banks’ free reserves needed to be accompanied by greater flexibility in interest rates. Despite the concern that significant increases in interest rates could threaten private sector recovery, the BNR reviewed its instruments, and eventually allowed interest rates to be determined freely. The BNR focused its attention on controlling the free reserves of the banking system. In that context, interest rates were expected to rise as credit demand recovered and banks began to feel the need to attract new deposits. By 2002, the BNR had redefined its monetary policy framework, with a whole set of indirect instruments of monetary policy, including cash auctions, restructured treasury bill issues, and an improved reserve requirement system. Base money had replaced the net domestic assets of the central bank as an intermediate target for monetary policy.

The BNR continues to use a base-money-control framework, with three policy instruments: credit or deposit auctions, treasury bill auctions (for monetary policy purposes), and foreign exchange auctions. In August 2005, the BNR introduced a corridor for money market rates and policy interventions (Figure 1.1.). It now also sets and communicates to the market a central bank policy interest rate (the “taux directeur,” which was set at 9 percent as of late 2006).

Figure 1.1.Rwanda: The BNR’s Interest Rate Corridor

Reconstruction of the National Bank of Rwanda

The BNR reopened on October 31, 1994, after the detailed inventory of remaining stocks of bank notes was completed and access to the BNR’s computer system and vaults had been restored. However, it was faced with quite a different situation from the one prevailing before the genocide: a large number of senior positions were now held by new staff and the organization needed to adapt to the new responsibilities and functions of managing a liberal exchange and monetary system. The BNR had to recreate itself entirely. Immediate priorities included: (a) drafting and enacting new central bank and commercial banking laws; (b) reorganizing in line with the new functions; and (c) getting the new staff up to speed as quickly as possible. The BNR quickly rose to the challenge, transforming itself into one of the most effective central banks in the region:

  • Central bank law: The BNR drafted a central bank law that would underpin its independence in conducting monetary policy. Work is still ongoing in this area because, while the new law adopted in mid-1997 contains most of the essential elements for the efficient functioning of a central bank, it falls short in a number of regards, including the independence of the BNR and the members of its decision-making bodies.
  • Reorganization of the BNR: In 1995, while good progress had been achieved in terms of restaffing, the organization was hardly conducive to the implementation of more flexible monetary and exchange rate policies, and still reflected its previous paradigm of centralized control, in particular of credit and foreign exchange. The BNR launched a major reorganization, which emphasized its new functional responsibilities. Six main departments were designed around strategic functions. In addition, a separate internal audit unit was created reporting directly to the Governor.
  • Internal audit: The BNR has worked to improve its internal audit mechanisms, particularly since the IMF’s 2003 Safeguards Assessment.3 The Internal Audit Department has made significant progress, and operates as an independent audit function, with its roles and responsibilities defined in an Audit Charter. It also has a governor approved audit plan, and risk-based auditing is applied. Work is ongoing to complete the agenda to ensure consistency with international audit standards.

Restoration of the Commercial Banking Sector

In parallel to making efforts to restore its own basic functions, the BNR needed urgently to address the poor health of the banking sector. Commercial banks were plagued even before the conflict by a wide range of weaknesses, including undercapitalization, low-yielding assets, lack of long-term resources, high levels of nonperforming loans (NPLs), and weak management. These problems were exacerbated by the conflict, which affected banks both directly, through loss of skilled personnel and damage to property (ransacked premises, loss of cash and equipment), and indirectly, through difficulties experienced by their clients. The proportion of NPLs increased significantly. Some debtors disappeared, while some of the new clients were foreigners, without verifiable collateral, and others clamored for additional loans to restore their capital and rebuild their businesses. Legal disputes, especially over withdrawals made during the conflict, were widespread.

The government launched steps to reconstruct the financial sector, starting with the reopening of commercial banks. The Banque de Kigali (BK) was the first to reopen, on October 12, 1994, and the Banque Commerciale du Rwanda (BCR) followed in December. The other commercial bank operating before the genocide—the Banque Continentale Africaine du Rwanda (BACAR)—did not reopen until the following year. In addition, two new banks were licensed in May 1995, bringing the total of commercial banks to five: the Banque pour le Commerce, le Développement et l’Industrie (BCDI) (established by Rwandese shareholders), and Gold Trust Bank of Rwanda Limited (BANCOR, a subsidiary of Gold Trust Bank of Uganda).

The focus shifted to efforts to lay the foundation for a sounder and more efficient system, including recapitalization and provisioning. In 1996, audits of the commercial banks and the Rwanda Development Bank (BDR) confirmed the poor shape of the banks’ loan portfolios and the generally unhealthy condition of the banking sector. The audits led to the drafting of three-year (1996–1999) restructuring plans. The results of these first reconstruction plans were satisfactory, and the two largest commercial banks (BK and BCR) and the BDR improved their financial positions during 1996–97. However, the level of NPLs sector-wide continued to be a problem. In addition, the real estate boom of the late 1990s, led by post-genocide reconstruction and relief activities, was coming to an abrupt end as non-governmental organizations (NGOs) started pulling out of the country. New audits commissioned in 1998 revealed the precarious financial situation of two banks, for which another restructuring plan (2000–2002) was prepared.

However, the new plans and the capital injections did not fully address the weaknesses in the banking system, and commercial banks continued to suffer from poor asset quality, risk concentration, and governance problems. The ratio of NPLs to total credit to the private sector rose from 10 percent in 1993, to 20 percent at end-1997 and to over 50 percent by end-2003.

The government has, until recently, continued to play a significant role in the financial sector. Although it did not take an active part in their management, the government had important minority shares in the two largest commercial banks, the BK and the BCR, as well as a modest share in BACAR. It also owned a majority share and took an active part in the management of the BRD. A significant step forward was the privatization in 2004 of the BCR and the BACAR.

Strengthening the Regulatory and Supervisory Environment

The BNR has also achieved significant progress in strengthening the supervisory and regulatory environment for banking, even while operating in a context of weak initial conditions for effective banking supervision. In particular:

  • Banking law: As part of the modernization of the banking system, the Rwandan government enacted a banking law in 1999 that defined banks, distinguishing them from nonbank financial institutions, and laid out the activities that they may engage in and the process for creating them. It also gave the BNR explicit authority to determine capital requirements and associated accounting requirements, and to enforce the banking law, including through the issuance of instructions to clarify the law and through the authority to impose penalties. In addition, it required the BNR to create a deposit insurance system. The BNR submitted to parliament a draft new banking law, which is to provide a comprehensive, modern, and adequate framework for banking supervision. Improvements include clarification and strengthening of the licensing process, the framework for lending to bank-related parties, and corrective measures. In addition, the BNR would replace the courts as the main body responsible for supervising the forced liquidation of banks.
  • Strengthening of prudential rules: Following the passing of the 1999 banking law, the BNR adopted a set of prudential rules, some of which had an immediate positive effect in strengthening the banks (regulations on the capital adequacy ratio, foreign exchange positions, classification and provisioning of assets, and risk diversification and the introduction of International Financial Reporting Standards (IFRS)-based accounting standards for the banking sector). Compliance with these regulations has been improving despite continuing problems related to poor asset quality, risk concentration, and governance issues. Nevertheless, breaches of the rules are frequent and occasionally substantial.
  • Strengthening of banking supervision: To address shortcomings in the organization of banking supervision, the BNR prepared an action plan in 2001 for gradual strengthening of the operational aspects of banking supervision, which has largely been implemented.

Modernization of the Payments System

For most of the post-genocide decade, Rwanda’s payments system underwent few changes. The system continued to be dominated by cash payments (80 percent of the operations), and the population had little confidence in checks. In addition, scant use was made of the opportunities for efficiency gains offered by computers and telecommunication, and activities related to the receipt, transportation, and security of banknotes absorbed substantial resources. In 2002, however, the government launched a far-reaching plan for the modernization of the payments system, including plans to allow domestic banks to issue debit and credit cards, restore the credibility of checks, and introduce automated clearing. The BNR and six commercial banks, as well as the Union des Banques Populaires du Rwanda and the Office Nationale de Poste, agreed to create SIMTEL (Societe Interbancaire de Monétique et de Télécompensation-an interbank eletronic payment initiative), which is intended to be the center of the payments system modernization efforts in Rwanda.

The IMF’s Support for Rwanda’s Reconstruction

The efforts of the Rwandese government were accompanied by strong support from the international community. This was viewed as essential not only in ensuring a smooth transition to sustainable growth, but also to prop up national reconciliation efforts and consolidate stability in the rest of the sub-region. As part of its response, the IMF prepared, in coordination with other donors, a comprehensive technical assistance program, to support Rwanda’s efforts to rebuild its capacity for economic management and for the compilation of economic and financial statistics.

In that framework, the IMF worked with the BNR to help it restore its basic functions, introduce a flexible exchange-rate regime, introduce indirect instruments of monetary policy, and strengthen the financial sector legal and regulatory framework—including through the drafting of a new banking law and new banking supervision regulations. Assistance has also been provided in assessing the desirability of a deposit insurance scheme. Rwanda has benefited from assistance in monetary operations, foreign reserve management and banking supervision through the regional technical assistance center (AFRITAC-East)4 and under the Enhanced Heavily Indebted Poor Country Initiative (HIPC) and the Multilateral Debt Relief Initiative (MDRI). In 2004–2005, the country underwent a Financial Sector Assessment Program (FSAP), which noted the progress made, but also highlighted some vulnerabilities and some priority structural reforms for financial sector development.

The IMF has also provided financial support under successive arrangements, with the focus moving gradually from post-conflict assistance, to sustainable growth and poverty reduction.

The Challenges Ahead

Rwanda has made significant progress since the genocide of 1994. In a context of subdued inflation, real GDP growth has been robust, and has remained at an average of 6 percent for the past few years, led by a recovery in agriculture, and an expansion in the manufacturing, financial, and communications sectors. The government has worked steadily with its international partners to achieve economic progress, and to rebuild its institutions, particularly the BNR, which is well managed, with a sound strategic approach.

In parallel to its own reconstruction, the BNR has managed to maintain the momentum for policy and structural reform in the areas of its competency. In the monetary area, the policy framework has been adapted significantly from the administrative controls of the post-colonial era, to a system of indirect monetary control and market-determined prices. An interest rate corridor was successfully introduced in August 2005, and the present mix of instruments has successfully helped to contain inflation over time. A more flexible exchange rate regime is in place and the parallel market has been absorbed. Marked improvements have also been achieved in the financial sector, many of them initiated by the BNR, including the privatization of state-owned banks, the restructuring and recapitalization of delinquent banks, and significant improvements in banking supervision and the regulatory environment. The BNR has also launched efforts to develop the country’s framework for anti-money laundering and combating the financing of terrorism (AML/CFT).

Nevertheless, as the focus shifts from reconstruction to sustainable development, the BNR will be grappling with a number of difficult challenges. Specifically:

  • In the monetary area, increases in donor assistance will continue to complicate the sterilization of excess liquidity. The central bank is concerned by the continuous exchange rate appreciation and the consequences on external competitiveness and exporters’ ability to repay their bank loans. It is also concerned about the cost of issuing government bills and the risk of crowding out private investment. Another major challenge will be to move from day-to-day monetary management allowing further play to the markets, which in turn requires increasing the capacity to understand underlying monetary trends and their policy implications, in a context of still serious capacity constraints.
  • Regarding foreign exchange, attention is likely to focus on the development of an interbank market, which remains underdeveloped despite a benign regulatory environment.
  • In the financial sector, the FSAP completed in 2005 highlighted a number of important challenges.5 The financial system remains shallow, especially outside the banking sector, while access to credit is limited. Banking operations continue to be concentrated in the capital, Kigali, and most bank credit goes to a small number of corporations in the trade, tourism, property development, and manufacturing sectors. Despite ongoing efforts, financial deepening is still hindered by weaknesses in the legal and institutional infrastructure for banking and finance, and shortcomings also persist in the accounting and auditing systems. Moreover, while the recapitalization and privatization of banks since 1994 has strengthened their short-term resilience, some structural weaknesses still need to be addressed.

The Rwandan government is working with external partners to address the above challenges. The plan is complemented by several initiatives, in particular an IMF Poverty Reduction and Growth Facility (PRGF) and a Financial Sector Development Program (FSDP) supported by the World Bank, the IMF, and the FIRST Initiative.6 The FSDP will address issues raised by the FSAP, in particular the monetary policy and foreign exchange operations framework, internal audit practices, and the legal and regulatory framework for banking supervision.

Beyond the monetary and financial issues outlined in this chapter, the country is faced with other daunting constraints in achieving the sustained high growth rates necessary to advance toward the Millennium Development Goals, while preserving macroeconomic stability. These include its continuing vulnerability to external shocks, its high dependence on external aid, and instability in the Great Lakes region. Clearly, continued strong government commitment, and international support will be essential. The achievements over the past decade augur well for the future.

1This transitional Government of National Unity led the country until August 2003, when the country held its first multi-candidate national elections since independence; President Paul Kagame was elected to a seven-year term.
2The BNR also had a rediscount window against government securities (T-bills and development bonds) and prime quality private paper. The posted refinance rate was 11 percent. However, the window was rarely used, given the excess reserves in the banking system.
3When the IMF provides a loan to a country, money is usually transferred to the country’s central bank. Before doing so, however, the IMF assesses the central bank’s financial control systems, to ensure it is able to manage the resources adequately and provide reliable information. All countries that request a loan from the IMF must undergo such a “safeguards assessment.”
4The IMF is increasingly adopting a regional approach to provide technical assistance to groups of countries confronted with similar economic problems. It has established six regional technical assistance centers—in the Pacific, the Caribbean, Central, East and West Africa, and the Middle East—to help countries strengthen their human and institutional capacity to design and enact policies that promote growth and reduce poverty.
5Rwanda, FSAP Report (2005) available on the Web at:
6The Financial Sector Reform and Strengthening (FIRST) Initiative is a multi-donor program, supporting capacity building and policy development projects in the financial sector. It provides technical assistance grants for short and medium-term projects in the areas of financial sector regulation, supervision and development.

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