An Investigation into the Efficacy of Monetary Policy Transmission in

Mauritius

Prepared by Danielle Dobos

August 2014

The views expressed in this report are those of the author and should not be taken as the views of

the Ministry of Finance and Economic Development or as Ministry policy.

Abstract

This report examines transmission mechanism failures in the Mauritian monetary policy system.

We find that interbank rates do not follow policy rates set by the central bank of Mauritius due to

a buildup of excess liquidity in the system and other confounding factors. Possible explanations

for these factors include an underdeveloped market for government securities, an

underdeveloped interbank market, and imperfect competition in the banking sector. Available

data suggests that an underdeveloped secondary securities market and imperfect competition are

the most likely transmission mechanism failures and contribute to the buildup of excess liquidity

in Mauritius, although there is a need for further analysis with more comprehensive data to draw

definitive conclusions.

I. Introduction

Monetary policy plays an important role in combatting inflation and maintaining price stability

in modern economies. Its transmission mechanisms are well documented in high-income

countries with a large formal financial sector, but less so in low-income and middle-income

economies such as Mauritius.

Mauritius has experienced substantial macroeconomic success since its financial liberalization in

the 1980s. It ranks 20th

in the world in the World Bank’s Ease of Doing Business score and saw

its inflation tumble from double digits in 2008 to a rate that now hovers between 3 and 5%.1

With price stability the primary mandate of the country’s central bank it would seem that

Mauritius enjoys successful monetary policy transmission; however, there have been doubts cast

on the efficacy of Mauritian monetary policy in the last decade. The central bank had difficulty

responding to foreign crises under its old policy rate regime2 and a recent working paper by the

IMF found evidence of a weak transmission mechanism under the new policy rate.3

Policymakers attribute this inefficiency to a build-up of excess liquidity in the banking system,

which has long been known to break down a central bank’s ability to employ open market

operations. While the government has made repeated attempts to sterilize this liquidity, the

persistence of the problem calls into question whether excess liquidity is the only breach in the

Mauritian monetary system or if there are deeper, underlying problems involving the

transmission mechanism at play.

This report will explore the efficacy of monetary policy transmission in Mauritius. The purpose

and structure of the report will be two-fold: Section II will investigate the efficacy of Mauritian

monetary policy and the role of excess liquidity by reviewing the four transmission mechanisms

of monetary policy, summarizing developments in Mauritian monetary policy history, and then

analyzing the transmission between current interest rates. Section III will explore possible

explanations for breaches in the Mauritian transmission mechanism beyond excess liquidity,

including an underdeveloped secondary market for government securities, underdeveloped

interbank market, and imperfect competition in the banking sector. Section IV concludes.

II. Mauritian Monetary Policy

A. The Four Primary Transmission Channels

The transmission mechanism of monetary policy refers to the channel through which changes to

the central bank’s policy rate affect aggregate demand and inflation. There are six primary

1 Bheenick, R. (2010, November).

2 The Bank of Mauritius switched from using the Lombard rate as its key policy rate to the key repo rate in 2003.

See Punchoo (2004). 3 Tsangarides (2010)

transmission channels, four of which are utilized in emerging economies: (i) The interest rate

channel (ii) The credit channel (iii) The exchange rate channel and (iv) the expectations channel.

Each of these channels begins through a change in the policy rate.

The Policy Rate Corridor

Central banks begin the process of changes in monetary policy by practicing open market

operations—the purchase or sale of short-term government securities4. Under an expansionary

monetary policy the central bank would purchase short-term securities from banks, thereby

increasing each bank’s amount of free reserves.

This increase in reserve supply would result in a reduction of the interbank rate as banks find

themselves with larger amount of reserves to lend in the overnight interbank market. The

interbank rate should remain within a corridor set by the policy rate of the central bank. The

interbank should not dip below the interest rate at which the central bank sells securities or else

we would expect to see banks reallocate their reserves to purchase securities that provide a

higher rate of return. Conversely, the interbank rate should not climb higher than the rate at

which the central bank purchases securities, as cash-strapped banks could obtain extra funds by

selling securities rather than face the high rates of an interbank loan.

In this manner, the central bank can manipulate the interbank lending rate which then affects the

larger economy through the various transmission channels.

The Interest Rate Channel

The reduced interbank lending rate makes it less costly for banks to obtain funds. In a

competitive industry, banks should pass on these reduced costs to lower lending rates, and as a

consequence of a lower return on assets (both interbank loans and loans to the nonbank sector),

reduced deposit rates as well. This reduction in short-term interest rates affects household

savings and consumption decisions through the interest rate channel, where lower deposit rates

spur consumption and a higher aggregate demand.

The Credit Channel

The increase in bank reserves should also leave banks more willing to extend credit to the private

sector, increasing consumption and aggregate demand through the bank lending channel of the

larger credit channel. The bank lending channel functions properly when securities are not close

substitutes for deposits—or in other words, when banks can make higher profits by providing

loans to the private sector than they can by purchasing more securities.

4 Many central banks, including the Bank of Mauritius, now use short-term repurchase agreements (repos or reverse

repos) where securities are traded for cash or vice versa and agreed to be repurchased at a later date. Repos carry a

lower credit risk than traditional open market operations and allow greater flexibility although their role as a

monetary policy instrument remains the same.

The Exchange Rate Channel

Decreased short term interest rates will lead to a depreciation of a country’s currency. A

depreciated currency will lead to a rise in demand for the country’s exports, increasing aggregate

demand and inflation through the exchange rate channel.

The Expectations Channel

Recent literature (Friedman & Kuttner, 2010) postulates that monetary policy can have a large

influence on interest rates through expectations of future interest rate changes rather than through

actual manipulation of the money supply. In this sense, central banks may be able to increase the

effectiveness of monetary policy with clear signaling of the policy rate and strong

communication to banks.

Credit Channel

Interest Channel

Exchange Rate Channel

Box 1: Monetary Policy Transmission Channel

An Example of Expansionist Policy

Source: Author

Rate

B. Review of Mauritian Monetary Policy Framework

The Bank of Mauritius (BoM) operates as the independent central bank in Mauritius. Founded in

1966 with the core mandate of maintaining price stability, the BoM acts as both a regulator and

formulator of monetary policy. It would previously intervene directly in the reserve ratios and

interest rate spreads of banks, but underwent financial liberalization in the late 1980s. The Bank

of Mauritius now uses policy rates and open market operations to indirectly influence the

economy.

The BoM initially targeted reserve quantities and used the bank rate—the overall weighted yield

of weekly auctioned treasury bills—as its key policy rate. The bank rate was market determined,

with the BoM only able to manipulate rates through controlling the amount of treasuries

auctioned each week, leading to a confusing, and often ineffective monetary policy framework.

The BoM was unable to raise interest rates in response to the rapid depreciation of the Asian

Crisis in 1998, prompting a switch to a new policy rate—the Lombard rate—in 1999.

The Lombard rate is defined as the discount window rate, or the rate at which commercial banks

can borrow from the central bank as a lender of last resort. The Lombard rate enjoyed initial

success but a widening gap between the Lombard and the interbank rate prompted renewed

concern. In 2007, in keeping with international standards Mauritius switched to a corridor system

using the key repo rate (KRR) as its main policy rate. Under this system, the BoM sells securities

through repo transactions at a rate 50 basis points below the KRR, and purchases securities

through reverse repos at a rate of 50 basis points above the KRR. This corridor was widened to ±125 basis points following the 2008 financial crisis.

1967 – Creation of the Bank of Mauritius (BoM)

1967 – 1986 – Period of direct control over monetary policy: The BoM controlled monetary policy through direct intervention with high reserve requirements, credit ceilings, and interest rate ceilings

1986 – 1996 – Financial liberalization: The BoM gradually switched to open market operations to control monetary policy by buying and selling BoM treasuries and acting as a lender of last resort

1987 – Liberalization of Bank rate: The bank rate, the overall weighted yield of weekly auctioned government treasury bills, was opened up to market forces and used as BoM’s key policy rate.

1999 – BoM switches to Lombard rate: In light of its inability to raise the interest rate to combat the rampant depreciation of the Asian Crisis (1998), the BoM switched to the Lombard rate to signal its stance of . The Lombard rate is the overnight lending rate for commercial banks to borrow from the BoM.

2004 – Bank of Mauritius Act of 2004: The primary objective of the BoM to “maintain price stability and to promote orderly and balanced economic development” was reinforced, and a permanent monetary policy committee (MPC) was created

2007 – BoM switches to Key Repo rate: A widening gap between the Lombard and in interbank rate prompted the BoM to switch to the key repo rate (KRR) as its signal rate. The “corridor” for the interbank rate was set at ±50 basis points from the KRR.

2008 – BoM increases corridor: The BoM increased the corridor breadth to ±125 basis points in response to the global financial crisis

Source: Punchoo (2004); Tsangarides (2010); Jankee (1999).

Box 1: Timeline of Mauritian Monetary Policy

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Graph 1: The Interbank and Key Repo Rate

KRR

Interbank

KRR + 125bp

KRR - 125bp2

C. Analysis of the Current System

In light of past problems with the policy rate, it is prudent to evaluate the success of monetary

policy under the key repo rate corridor system. Each of the primary transmission channels of

monetary policy relies on successful pass-through from the policy rate to interbank lending rates,

with the interbank rate expected to remain within the corridor created by the KRR. Graph 1

demonstrates that this is not the case in Mauritius. Interbank rates fluctuate in and outside of the

KRR corridor from January 2007 to December 2008, and remain consistently below the reverse

repo rate after January 2009.

Source: Data from BoM Monthly Statistical Bulletin.

Graph 2 quantifies the gap between the KRR and interbank rate. During the period from January

2007 to March 2008 the interbank rate remained with the original ±50 bp corridor 7 out of 15

months – a 46.67% success rate. After the corridor was expanded to ±125bp in April 2008, the

interbank rate only remained within the KRR corridor 7 out of 73 months—a 9.56% success rate.

Source: Data from BoM Monthly Statistical Bulletin.

Interbank rates have been known to fluctuate outside of policy rate corridors for several reasons.

Interbank rates may be higher than the rate at which governments purchase securities if a bank

wants to avoid the stigma of going to the central bank for overnight funds. Doing so may portray

the commercial bank as risky, and may make it more difficult to obtain overnight interbank loans

in the future.

More often—as is the case in Mauritius—interbank rates drop below the rate of return on

government securities. There are several possible causes for this phenomenon, although it is

most commonly associated with excess liquidity in the banking sector. If all banks hold excess

reserves and there is little demand for interbank loans, then the interbank rate will drop below the

interest rate on government securities. Excess liquidity can be either structural or cyclical:

cyclical excess liquidity is a result of large capital inflows through avenues such as foreign direct

investment, while structural excess liquidity is a result of a lack of investment opportunities in

the domestic market.

Graph 3 shows the buildup of excess liquidity in Mauritius since 2007. Excess liquidity peaked

in March 2011 with over 12,590 million rupees of surplus reserves in the banking sector, and

after an initial drop in response to the government issuing short-term securities5, has been

climbing again. While the buildup of these excess reserves certainly has an effect on monetary

policy, there are two pieces of evidence that support the hypothesis that excess liquidity is not

the only breach in the Mauritian monetary system.

5 Central governments frequently respond to excess liquidity in the system by either increasing reserve ratios or

selling short-term securities to sterilize excess reserves. The sale of short-term government securities to commercial

banks is referred to as “mopping up” excess liquidity.

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Graph 2: The Gap between the KRR and Interbank Rate

Gap (KRR - Interbank)

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Graph 3: Excess Liquidity

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Graph 4: Excess Liquidity and the Gap between the KRR and Interbank Rate

Excess Liquidity Gap (KRR - Interbank)

(1) If excess liquidity is the only cause

of a declining interbank rate we would

expect to see a strong correlation

between the amount of excess liquidity

in the system and the gap between the

policy rate and the interbank rate.

Graph 4, however, depicts little to no

linear correlation between these two

indicators. The gap remains high

throughout 2007 despite relatively low

levels of excess liquidity during this

period, fluctuates from 2008 to 2014,

and declines beginning in 2014 despite

increasing levels of excess liquidity.

The lack of linear correlation between

the two variables does not mean that excess liquidity is not pulling down interbank rates, but it

does suggest that there are other variables at play.

(2) Mauritius’s historical experience with monetary policy also hints at other problems involving

the transmission mechanism. Mauritius contended with ineffective policy rate pass-through

under both the bank rate and the Lombard rate, despite very low levels of excess liquidity in the

system. Graph 5 depicts the low correlation between the Lombard rate and the interbank rate

from 2003 to 2007, where there was less than 2,500 million rupees over the federal reserve

requirement.

(Rs

mill

ion

s)

(%)

Source: Data from BoM Monthly Statistical Bulletin.

Source: Data from BoM Monthly Statistical Bulletin.

Source: Data from BoM Statistical Bulletin.

These two facts combined suggest that there are other breaches in the monetary policy

transmission mechanism. The rest of this report will explore possible explanations of for the

failed transmission mechanism and evaluate the likelihood of each transgression.

III. Transmission Mechanism Failures

A. Review of Possible Transmission Mechanism Failures

As the previous section demonstrated, monetary policy pass-through is a complex, multi-step

process that relies on several underlying assumptions. As Mishra, Montiel, and Spilimbergo

(2010) argue in a working paper for the IMF, these underlying assumptions are not always valid

for low-income or middle-income economies. Traditional monetary policy transmission assumes

the following institutional background:

A large and diverse formal financial sector where financial intermediation is protected

through a strong regulatory framework

An independent central bank

A highly developed and highly liquid secondary market for government securities

A highly developed and highly liquid interbank market for overnight loans

A floating exchange rate

A competitive banking sector6

Emerging economies rarely satisfy most or all of these conditions. Out of the preceding

assumptions, Mauritius enjoys a large formal financial sector, and independent central bank, and

a floating exchange rate. This leaves the most likely breaches in Mauritian monetary policy as

the result of i) An underdeveloped secondary market for government securities ii) An

underdeveloped interbank market or iii) Imperfect competition in the banking sector. The rest of

this section will elaborate on each assumption and explain its pertinence to effective monetary

6Montiel, Spilimbergo & Mishra, (2010)

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Graph 5: Correlation between the Lombard and Interbank Rate

Excess Liquidity (Mil Ru) Interbank Rate Lombard Rate

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policy. Available data will then be analyzed concerning each condition to determine how

applicable the assumption is to the Mauritian case.

B. Evaluation of Transmission Mechanism Failures

Underdeveloped Secondary Market for Government Securities

A large part of the pass-through from policy rates to interbank lending rates is dependent on a

well-developed secondary market for government securities. Governments typically hold

periodic primary auctions of government securities when they need to raise money and these

securities are assumed to be purchased by secondary players—commercial banks, other financial

intermediaries, or the nonbank public. These secondary players then trade different types of

securities (i.e. government, financial, corporate, short-term or long-term) in a well-developed

secondary market such as a stock exchange. In modern monetary policy central banks conduct

the sale and purchase of short-term securities in these secondary markets.

An underdeveloped (or nonexistent) secondary market for government securities leads to two

primary problems in the conduct of monetary policy. The first problem is a time lag between

policy rate and interbank rate pass-through. The lower bound of the policy rate corridor depends

on an arbitrage taking place between the interbank rate and the rate of return on short-term

securities7. The interbank rate and the rate of return on government securities should move

toward one another as securities are rolled over between commercial banks and other secondary

players until banks are at a point of indifference between holding securities or holding reserves.

Without competitive and highly liquid secondary markets this arbitrage cannot efficiently take

place, leading to a time lag in policy rate pass-through.

The second problem involves the buildup of involuntary excess liquidity. When banks hold

excess reserves they are assumed to use these reserves to expand lending (either to the interbank

market or nonbank public) or purchase securities for a higher rate of return. In the case where

opportunities for lending are low and there is an underdeveloped secondary market for securities

banks may be able to earn a higher rate of return on reserve deposits than they can through

remunerative alternatives8.

These considerations lead us to ask how developed are secondary markets in Mauritius? Table 1

provides some insight into the question. Table 1 displays the outstanding stock of domestic debt

securities by country and sector of issue as well as the ratio of outstanding stock of domestic debt

securities to GDP. Mauritius has the lowest outstanding stock of domestic securities across

sectors at 4.9 billion USD—in part owing to its small size—but a relatively high stock to GDP

ratio at 0. 411. For comparison with other upper middle-income countries Peru has a ratio of

0.126, Turkey of 0.251, and South Africa of 0.566.

7 Montiel, Spilimbergo & Mishra, (2010)

8 Saxegaard, (2006)

Table 1: Domestic Debt Securities by Sector of Issue

Stock (USD billion) 2013 Stock to GDP 2013 Stock to GDP mean 2010 - 2012

Country Total Government Financial Sector

Corporate Sector Total Government

Financial Sector

Corporate Sector Total Government

Financial Sector

Corporate Sector

Argentina 14.7 - 14.7 - 0.024 - 0.024 - 0.031 - 0.031 -

Australia 1255.2 499.6 709.0 46.7 0.804 0.320 0.454 0.030 0.967 0.334 0.599 0.035

Brazil 2000.5 1275.1 577.1 148.3 0.891 0.568 0.257 0.066 0.913 0.601 0.256 0.056

Canada 1689.5 1147.3 333.8 208.5 0.926 0.629 0.183 0.114 0.893 0.623 0.168 0.103

China 4084.7 1504.0 1762.3 818.4 0.442 0.163 0.191 0.089 0.478 0.162 0.223 0.093

Chile 133.5 33.0 69.8 30.8 0.482 0.119 0.252 0.111 0.485 0.104 0.243 0.137

Colombia 95.0 92.6 - 2.4 0.251 0.245 - 0.006 0.245 0.240 - 0.006

Hungary 96.7 63.8 32.5 0.3 0.767 0.506 0.258 0.002 0.588 0.394 0.189 0.005

India 634.8 634.8 - - 0.338 0.338 - - 0.212 0.212 - -

Indonesia 101.4 81.7 12.7 7.0 0.117 0.094 0.015 0.008 0.167 0.132 0.027 0.008

Israel 217.1 138.5 30.8 47.8 0.745 0.475 0.106 0.164 0.781 0.455 0.156 0.170

Japan 12041.2 9015.2 2390.9 635.1 2.457 1.839 0.488 0.130 2.550 1.836 0.565 0.149

Korea 1406.3 459.4 394.5 552.4 1.078 0.352 0.302 0.423 0.976 0.313 0.306 0.357

Malaysia 333.7 150.8 60.1 122.9 1.068 0.483 0.192 0.393 1.077 0.456 0.239 0.382

Mauritius9 4.9 4.90 0.004 0.005 0.411 0.410 0.000 0.000 0.413 0.413 0.000 0.000

Mexico 606.1 386.3 172.5 47.3 0.481 0.306 0.137 0.038 0.414 0.248 0.133 0.033

Peru 25.4 12.8 9.6 3.0 0.126 0.063 0.047 0.015 0.160 0.066 0.069 0.026

Philippines 89.5 86.4 - 3.0 0.329 0.318 - 0.011 0.322 0.308 0.000 0.014

Russia 284.6 126.3 75.0 83.3 0.136 0.060 0.036 0.040 0.118 0.056 0.025 0.038

Saudi Arabia 20.0 20.0 - - 0.027 0.027 - - 0.058 0.058 - -

Singapore 98.6 98.6 - - 0.331 0.331 - - 0.410 0.410 - -

South Africa 198.6 131.4 41.6 25.6 0.566 0.375 0.119 0.073 0.545 0.343 0.128 0.073

Switzerland 218.3 114.7 85.9 17.7 0.335 0.176 0.132 0.027 0.328 0.181 0.118 0.028

Thailand 264.9 93.9 123.6 47.4 0.684 0.242 0.319 0.122 0.800 0.262 0.416 0.123

Turkey 205.6 188.7 15.1 1.8 0.251 0.230 0.018 0.002 0.290 0.280 0.010 0.000

Source: Data from BIS, Stock of Domestic Debt Securities by Residence and Sector of Isssue. Country GDP from World Bank World Development Indicators.

9 Domestic debt security data for Mauritius was not available from the BIS. Data for government securities was gathered from the Bank of Mauritius monthly

statistical bulletin and data for financial and corporate securities was provided by the Stock Exchange of Mauritius. Financial and corporate securities data for

Mauritius is not available for 2010.

However, a closer look reveals that the central government issues almost the entirety of

Mauritian debt securities. Financial and corporate securities make up a negligible fraction of the

total stock,10

suggesting an underdeveloped secondary market for securities. Further

investigation into the Stock Exchange of Mauritius reveals that there are only four major

companies issuing debenture11

and two out of the country’s twenty-one commercial banks. In

addition, government securities are primarily traded through the Secondary Market Cell of the

Bank of Mauritius rather than through the Stock Exchange of Mauritius. These factors indicate a

low level of secondary market development in the country with adverse effects on monetary

policy.

Underdeveloped Interbank Market

Interbank markets play a pivotal role in the conduct of monetary policy and the functioning of

the banking system. A well-developed and highly liquid interbank market gives commercial

banks access to overnight loans when they are short of funds, promoting greater stability and

flexibility in the financial sector. Assumed to be a standard feature in OECD countries, interbank

markets may not be as highly developed in low-income or middle-income economies.

Sacerdoti (2005) finds case study evidence that interbank markets are underdeveloped in Sub-

Saharan Africa. A poor regulatory environment and high cost of evaluating risk can lead to

mutual distrust among banks and dissuade them from lending to one another. The effect of

underdeveloped interbank markets on monetary policy transmission is debilitating—without a

functioning interbank market banks are more prone to build up excess liquidity (especially in the

frequently simultaneous case of an underdeveloped secondary securities market) and the central

bank has no way of enforcing the lower bound of the policy rate corridor.

Unfortunately, no comprehensive dataset or standard indicators exist to evaluate interbank

market development. Ideally we would examine the frequency, number, and volume of various

countries’ interbank loans and compare these values after adjusting for country GDP. Such

analysis would require access to detailed interbank transaction data and the application of a

Furfine-based algorithm12

to identify overnight interbank loans; however, this information is

generally confidential and not available to the public.

10

The figures for financial securities in Mauritius may be slightly lower than reality as data for the outstanding stock

of Bank of Mauritius securities was unavailable for analysis. 11

Data is from the Stock Exchange of Mauritius and does not include small to medium size enterprises. 12

Central banks commonly use Furfine-based algorithms to identify the overnight interbank lending rate. Furfine-

based algorithms identify overnight interbank loans by searching interbank transaction data for a transaction of

volume x made on day t (the initial loan) and a transaction of volume x + r where r is some range of possible

interbank interest rates on day t + 1 (the repayment of the initial loan) between the same market players. Furfine

algorithms have been shown to be generally accurate in identifying interbank loans—see Akram & Christophersen

(2013).

Instead, Graph 6 shows the annual volume of interbank loans in Mauritius. Growth has been

steady over the past decade—which is consistent with expectations for a developing market—in

comparison to the relatively constant and then declining interbank loan volumes of a developed

economy such as the US, which graph 7 depicts for comparison.

While it is not possible to draw a conclusion on Mauritian interbank market development without

more comprehensive data, it seems unlikely that underdeveloped interbank markets explain the

breach in monetary policy. The country’s strong regulatory framework and increasing volume of

interbank loans suggest a functioning interbank market.

Imperfect Competition

An important and often overlooked condition for effective monetary policy is the existence of a

competitive banking sector. Effective arbitrage between policy rates and interbank rates as well

as arbitrage between interbank rates and lending rates is dependent upon competition, yet

imperfect competition often exists in low-income and middle-income countries. The weaker

regulatory environment, lack of alternative nonbank financial institutions, and historical

importance of state-run banks all contribute to these conditions.13

Mauritius also faces an

inherent challenge in terms of market size due to its nature as a small island economy.

Imperfect competition in the banking sector can affect the conduct of monetary policy in two

primary channels. 1) Akram and Christophersen (2010) and Allen et al. (2012) find that

systematically important banks14

are able to obtain lower overnight loan rates in the Norwegian

13

Saxegaard, M. (2006). 14

Systematically important banks are defined as large, and well-connected banks that play an active role in the

interbank market and enjoy a sizable domestic market share.

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Graph 6: Volume of Interbank Loans in Mauritius

Interbank Loans

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Graph 7: Volume of Interbank Loans in the US

Yearly Avg of Interbank Loans (USbil)

Source: Data from BoM Monthly Statistical Bulletin.

Source: Data from St. Louis Federal Reserve

and Canadian interbank markets, respectively. This phenomenon was attributed to a “too big to

fail” effect after the recent financial crises but the implications of these findings for monetary

policy are far-reaching. In the case of imperfect competition, systematically important banks may

be able to use their market power to obtain more favorable lending rates and pull down the

average interbank rate in the process.

2) Mishra, Montiel, and Spilimbergo (2010) explain the effects of imperfect competition for the

pass-through from interbank lending rates to short-term interest rates. Under textbook economic

conditions, banks should pass on the reduced cost of interbank loans to lower lending rates as

they compete to attract customers. However, banks that wield considerable market power may

purposefully restrict lending with the result that changes in the interbank rate only affect bank

profit margins. These conditions may also lead to a buildup of excess liquidity in the system if

banks hold excess reserves rather than use them to lend on the interbank market or purchase

securities (see previous sections).

Several proxy measures exist for measuring competition in the banking industry. The

Herfindahl-Hirschman Index (HHI) measures concentration within an industry by summing the

squares of the 50 largest firms’ market shares15

. The index ranges from 0 to 10,000, with 0

indicating perfect competition and 10,000 indicating perfect concentration (a monopoly). The

Mauritian Bankers Association reported an HHI score for total assets of 1,078 in 2012 for the

Mauritian banking sector. Figure 1 displays total asset market share among Mauritian banks in

2013. An HHI index of 1,078 places Mauritius in the moderate band of market concentration,

although it is likely that domestic market concentration is much higher. Market share is usually

calculated as domestic deposit share rather than total assets since foreign deposits can skew

concentration numbers. This is especially relevant to the Mauritian case where a large number of

banks are foreign-owned subsidiaries. Unfortunately, domestic deposit share data is not currently

available to the public so it is difficult to draw conclusions on the true level of concentration in

the domestic banking industry.

15

The HHI index is used by the United States Department of Justice when evaluating the impact of mergers and

acquisitions in the domestic market.

Source: Data from Mauritian Bankers Association Profile of Banks 2014.

It is important to note that concentration alone does not necessarily indicate imperfect

competition. The two measures are generally correlated, but a new school of thought argues that

concentration in the banking sector actually strengthens stability in the financial system.16

As

such, we need to employ another proxy measure to evaluate the degree of imperfect competition

in the Mauritian banking sector. Bank profit margins can be such an indicator. In a non-

competitive industry we would expect to see firms reporting large profit margins—measured in

the banking sector through large net interest margins or interest rate spreads17

. Table 2 reports

both the net interest margin and interest rate spread of a sampling of countries. Mauritius reports

a moderate net interest margin of 2.99 in 2011, and a slightly higher interest rate spread of 4.89

in 2012. For comparison, other upper middle income countries such as Venezuela, South Africa,

and Malaysia report net interest margins and interest rate spreads of 7.40, 1.87; 2.76, 3.31; and

2.29, 8.89 respectively.

16

See Bheenick, R. (2010, August). 17

Net Interest Margin is defined as (Interest Received - Interest Paid) / Average Invested Assets and the Interest

Rate Spread is defined as (Lending Rates – Deposit Rates). See Demirgüç-Kunt & Huizinga (1998) for further

information on the correlation between concentration and large net interest margins in the banking sector.

0.71 3.07

3.21 1.72

1.81

11.31

1.48

0.02

2.48

0.19 15.66

4.05

1.72 0.13

3.59 7.06

9.94

10.82

21.05

Figure 1: Mauritian Banking Sector Total Asset Market Share 2013 (%)

ABC Bank Corporation Ltd

AfrAsia Bank Limited

Bank of Baroda

Bank One Limited

Banque des Mascareignes Ltee

Barclays Bank Mauritius Limited

Bramer Banking Corporation Ltd.

Century Banking Corporation Ltd.

Deutsche Bank (Mauritius) Limited

Habib Bank Limited

HSBC Bank (Mauritius) Limited

Investec Bank (Mauritius) Limited

Mauritius Post and Cooperative Bank Ltd.

P.T. Bank International Indonesia

SBI (Mauritius) Limited

Standard Bank (Mauritius) Limited

Standard Charted Bank (Mauritius) Limited

State Bank of Mauritius Ltd.

The Mauritius Commercial Bank Ltd.

Source: World Bank World Development Indicators.

Overall Mauritius only reports moderate indicators of imperfect competition in the banking

sector. However, it is impossible to draw definitive conclusions without access to bank domestic

deposit shares or detailed transaction data on loans in the interbank market.

IV. Conclusion

This report explored the efficacy of the current monetary policy framework in Mauritius.

Monetary policy is essential for combatting inflation and promoting price stability in emerging

economies, yet monetary policy transmission in these environments faces significant challenges.

We found that the pass-through between policy rates and interbank lending rates—the first step

in the four primary transmission channels—is impaired in Mauritius. Interbank lending rates

remain consistently below the lower bound of the policy rate corridor. This phenomenon has

been attributed to the buildup of excess liquidity in Mauritius but a low level of correlation

between the amount of excess liquidity in the system and the gap between policy and interbank

rates leads us to believe that there are other transmission failures.

18

Interest Rate Spread data for Mauritius is calculated from data from the Bank of Mauritius as (Weighted Average

Rupee Lending Rate – Weighted Average Rupee Deposit Rate).

Table 2: Profitability Measures of Banks

Country

Interest Rate Spread Net Interest Margin

2012 Mean 2000 - 2011 2011 Mean 2000 - 2010

Argentina 2.04 5.40 7.00 3.27

Australia 3.06 4.26 2.06 2.09

Brazil 28.73 37.54 4.97 6.44

Canada 2.52 3.30 3.23 2.13

China 3.00 3.31 2.74 2.47

Chile 4.27 4.03 - 3.56

Colombia 7.23 7.12 5.10 5.08

Hungary 3.72 2.38 3.31 4.29

Indonesia 5.85 5.41 6.32 5.41

Israel 3.35 3.63 1.40 2.36

Japan 0.93 1.45 1.01 1.23

Korea 1.70 1.65 2.65 2.39

Malaysia 1.81 3.14 2.60 3.25

Mauritius18

4.89 4.73 2.99 3.24

Mexico 3.65 5.16 2.92 5.93

Peru 16.78 19.21 5.94 6.32

Philippines 2.52 4.24 3.65 3.99

Russia 3.57 8.15 3.93 4.79

Singapore 5.24 4.77 1.52 1.78

Seychelles 8.89 7.02 2.29 4.03

South Africa 3.31 4.22 2.76 4.05

Thailand 4.30 4.44 2.94 2.79

Ukraine 5.43 11.34 6.15 6.73 Venezuela 1.87 5.83 7.40 9.84

The second part of this report explored three explanations for these transmission failures—an

underdeveloped secondary securities market, an underdeveloped interbank market, and imperfect

competition in the banking sector. We found evidence of an underdeveloped secondary market in

Mauritius, possibly leading to large time lags in monetary policy and the buildup of excess

liquidity. Little data was available to evaluate the development of the Mauritian interbank

market, but there is a lack of a priori evidence for an underdeveloped market with Mauritius’s

strong regulatory framework. Some indicators were found for imperfect competition in the

banking sector—which can also lead to artificially low interbank rates and the buildup of excess

liquidity—but it is impossible to draw definitive conclusions with the current data gaps.

As such, the recommendations for this report primarily involve improvements in data collection

and reporting. Mauritius should closely monitor the development of secondary securities markets

and report annual figures according to BIS guidelines in order to create an accurate development

record. In addition, the Bank of Mauritius or authorized independent researchers should analyze

interbank transaction data to evaluate the nature of the overnight interbank market. Particular

areas of research interest include the distribution of excess reserves in the banking sector and

whether systematically important banks receive more favorable lending rates. Finally, the

Competition Committee of Mauritius should compile data on domestic deposit market share

among banks in order to examine concentration and competition within the banking industry.

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