The Central Bank of The Bahamas (CBB) has long relied on direct credit controls and restrictions on capital flows to manage liquidity, as the depth of the domestic credit market was seen as insufficient to support open market operations. But more recently, it has become concerned about the microeconomic distortions resulting from its direct controls and is reconsidering its monetary framework. For this reason, the IMF recently discussed with the CBB a strategy to set the stage for a successful transition toward market-based instruments of liquidity management in an effort to enhance the role of price signals in allocating financial resources.
The Bahamian dollar has been pegged at par with the U.S. dollar since 1973, and keeping an adequate level of international reserves has been a key objective. The CBB is required to have external assets equivalent to at least 50 percent of its demand liabilities. In practice, since 2003, reserves have been targeted at 100 percent of base money or more, well in excess of the statutory limit. The Monetary Policy Committee (the CBB’s monetary policy decision-making body) monitors monetary and bank soundness indicators and takes corrective action if losses of international reserves threaten to put pressure on the exchange rate.
Since the late 1980s, the CBB has been relying on direct credit controls as its main monetary policy instrument, with changes in the discount rate playing a secondary and infrequent role. Credit growth is seen as a key intermediate target given its importance in achieving the Bank’s reserve objective through its effects on domestic demand, which is highly import-intensive. During the most recent episode of credit controls (September 2001–August 2004), the CBB introduced a ceiling on bank loans and advances to the private and public sectors, supported both by moral suasion and existing capital controls.
The current framework has worked reasonably well in achieving policy objectives. From September 2001 to end-2003, aggregate bank credit growth gradually declined to near zero, and international reserves recovered sharply from the low level experienced in the wake of the post-September 11 drop in tourism revenues (see chart). A considerable degree of monetary independence was also evident, with domestic interest rates remaining broadly stable, in contrast to the sharp swings in U.S. rates.
The insulation of domestic interest rates from U.S. rates is largely a consequence of exchange controls, but it also reflects a seeming absence of price competition among banks. Eight clearing banks operate in the domestic commercial banking sector, of which one is government-owned, two are locally owned private banks, and five are subsidiaries or branches of foreign banks. In addition there are 11 nonbank financial institutions of a smaller size. Even in the face of large excess bank liquidity, bank deposit and lending rates have been remarkably stable and banks appear not to compete through interest rates. This may be an unintended consequence of the long-standing reliance on credit controls, which have reduced the scope and incentive for banks to gain market shares by adjusting lending rates.