Banks play an important role in our lives, and not just because they are how we manage our money. Banks also make possible many modern conveniences, like being able to securely send or receive money, pay with a card or mobile phone instead of cash, sign up for services online, and more. Banks also finance the businesses that provide all these products and services, and their rates, fees, and policies have a big impact on the economy. But if you scratch further, it goes even deeper—all the way down to the Central Bank of Egypt (CBE).
The CBE has a number of functions, from issuing the EGP and managing Egypt’s money supply to regulating Egypt’s banks and implementing the national monetary policy. But it also acts like any other bank; the CBE holds deposits, makes loans, and transfers money. The difference is that the CBE’s customers are not individuals or businesses, its customers are the country’s banks.
Just like any bank, the CBE sets fees and rates for the services it provides. For example, the CBE holds the nation’s foreign currency reserves and publishes the rates at which banks can exchange currencies. It sells Egypt’s treasury bills and sets the interest rate on them. And of course, it sets the amount of interest it charges when it lends money.
The key rate, which we’ll discuss here, is what’s called the discount rate, but before we get to it, we’ll need to talk a little bit more about the CBE’s role.
As part of its job to supervise Egypt’s banks, the CBE requires them to always keep a certain percentage of their deposits on hand as reserve. If, at the end of the day, a bank does not have enough money to meet its reserve requirements, it borrows from other banks. The interest rate that banks charge each other for these transfers is called the overnight rate. But sometimes it’s better or cheaper for a bank to borrow from the CBE, and the interest rate that the CBE charges for these loans is the discount rate.
So why is the discount rate so fundamental?
As we mentioned, a key function of the CBE is managing Egypt’s national monetary policy, and its goal is to keep the economy strong and growing. Right now, the main objective of Egypt’s monetary policy is keeping prices stable and inflation under control. In fact, on its website, the CBE says:
“The CBE is committed to achieving, over the medium term, low rates of inflation which it believes are essential for maintaining confidence and for sustaining high rates of investment and economic growth.”
The CBE has a number of tools for achieving this. Together, the discount rate, the value of Treasury bonds, and the reserve requirements that it sets for banks have a huge effect on the economy. Of these, the discount rate has the largest and most immediate impact.
For example, if the discount rate falls below the overnight rate, banks typically turn to the CBE rather than to each other to borrow funds. Which means that the discount rate can push the overnight rate up or down, and this affects not just the banks, but their customers. Banks charge their best, most creditworthy customers a rate that is very close to the overnight rate, and they charge their other customers a rate that is a bit higher. For example, if the discount rate is 1.5%, banks are likely to charge their customer's relatively low-interest rates, but if the discount rate is 12%, banks are going to charge borrowers much higher interest rates.
Clearly, the discount rate matters a lot to banks—but why does it matter to you? Of course if you have a credit card or a bank loan, higher interest rates are going to make these more expensive. But interest rates also affect people who do not borrow money because they directly affect the economy, everything from prices to jobs.
When interest rates are high, people and businesses are reluctant to borrow and more likely to save their money instead of spending it. As a result, businesses tend to lower their prices to attract customers. And when interest rates are low, borrowing money becomes more attractive, and people and businesses spend more. Not only does this drive prices up, but businesses tend to expand—increasing production, launching new products, and hiring more employees. And as the economy expands, it’s good for the value of the Egyptian Pound, and this too has its effects on imports and exports, which affect prices and the choices of Egypt’s businesses.
As the central bank for Egypt’s banks and as the custodian of Egypt’s economy, the CBE plays a role in all our lives. It’s a long chain of reactions, but it all begins with the discount rate.