Monetary Policy

Monetary Policy Framework

The Central Bank of Bahrain (CBB) is responsible for setting and implementing monetary policy in the Kingdom of Bahrain. Bahrain maintains a fixed exchange rate regime between the Bahraini dinar and the US dollar. The exchange rate peg provides an anchor for monetary policy. Low inflation and a stable currency are important long-term features of the Bahraini economy which support a stable business environment and high levels of investment, both of domestic and foreign origin.

Bahrain has a free market economy, with no restrictions on capital movements, foreign exchange, foreign trade or foreign investment. The Kingdom has a leading position in the region as an open, free, transparent and welcoming environment for investors. The monetary policy framework is geared to support the general economic goals of the Kingdom.

Monetary policy instruments

The Reserve Management Directorate of the CBB offers a foreign exchange facility for buying and selling Bahraini dinars against US dollar at rates very close to the official exchange rate.

  • CBB offers a set of deposit and lending standing facilities in Bahraini dinars to all retail banks. The interest rates on the standing facilities are the CBB policy interest rates. The CBB policy rates guide the short-term interest rates in the Bahraini money market, and ultimately influence the deposit and lending rates that the banks offer to customers.
  • CBB requires retail banks to hold unremunerated reserves with the CBB. The reserve requirement system contributes to adjust the CBB’s structural liquidity situation vis-à-vis the banking sector. The reserve requirement system is not intended to serve as an active monetary policy instrument for day-to-day liquidity management.

The CBB does not maintain any administrative controls over market interest rates. There are no interest rate caps or floors and the CBB does not seek to influence directly the cost of credit or the distribution of credit in the economy. The private sector is thus free to allocate credit as it sees fit.

The CBB monetary policy operations aim to ensure that the liquidity situation in the banking sector is appropriate. The Bahraini dinar liquidity of the retail banks consists mainly of the clearing account balances they hold with the CBB. These balances, which can be traded between banks in the money market, fluctuate from day to day, mainly as a consequence of the Government’s conversions of US dollar to finance its domestic expenditure, the retail banks purchase of US dollars from the CBB, changes in the amount of currency in circulation and changes in the banks’ reserve balances with the CBB.

Why is monetary policy centred on the exchange rate?

It is important to have a monetary arrangement which mirrors that of major trading partners. The Bahraini dinar is pegged to the US dollar. The peg has been effectively unchanged since 1980. The use of a large foreign currency as a nominal anchor for monetary policy is a frequent arrangement among small open economies and has proven to be successful if supported by appropriate fiscal and structural policies. The US dollar peg serves to enhance credibility and transparency of monetary policy to maintain financial stability.

Exchange Rate Policy

Bahrain maintains an exchange rate peg at 0.376 Bahraini dinars to the US dollar. The exchange rate peg provides an anchor for monetary policy, which contributes to controlling inflation and protecting the external value of the currency.

The CBB offers a foreign exchange facility, implying that it stands ready to buy and sell US dollars, at rates very close to the official exchange rate. The CBB provides this facility to retail banks located in the Kingdom of Bahrain.

Standing Facilities

The standing facilities are a set of deposit and lending instruments. The CBB offers the following standing facilities:

Deposit facilities

  • Overnight deposit facility
  • 1-week deposit facility lending facilities

1-month deposit facility

Overnight Wakalah deposit facility for Islamic retail Banks

1-week Wakalah deposit facility for Islamic retail Banks

  • Overnight lending facility against Bahraini dinar deposits at the CBB
  • Overnight repo facility against government securities
  • 1-week Islamic Sukuk Liquidity Instrument (ISLI) against Government Ijara Sukuk.

The mechanism of the Islamic Sukuk Liquidity Instrument (ISLI) is based on Sale and Purchase transactions meant to help Islamic banks in managing their liquidity. It involves three separate Sukuk sale and purchase transactions requiring the existence of three parties, namely the Sukuk owner (the bank in need of liquidity), the intermediary bank (the market maker) and the Central Bank of Bahrain (CBB) which offers the liquidity.

The standing facilities are available to retail banks, at their discretion, at the end of the daily trading session (after 1 p.m.).

Access to the 1-week and 1 month BHD deposit facilities are granted only on Tuesdays (or if Tuesday is a bank holiday, on the following business day).

-Access to the 1-week Wakalah BHD deposit facility is granted only on Tuesdays (or if Tuesday is a bank holiday, on the following business day).

The interest rates on the standing facilities are the CBB policy interest rates. The 1-week deposit rate is the CBB Key Policy Rate.

The CBB standing facilities rates are decided by a Monetary Policy Committee at the CBB. They are updated on a daily basis on the CBB website and the CBB’s Reuters and Bloomberg pages “CBOB”. The policy interest rates are updated at 10 a.m. each business day.

CBB Wakalah Facility

Wakalah Facility was launched in March 2015.

The agreement has been developed, based on a standard contract of the International Islamic Financial Market (IIFM).

The Wakalah is an investment opportunity for Islamic retail banks who wish to deposit excess liquidity with the CBB, overnight & one week.

Islamic retail banks need to sign a Wakalah agreement which appoints the CBB as an agent (Wakil) to invest cash on behalf of the bank (Muwakkil).  Accordingly, the Wakil will invest these funds in the investment portfolio allocated in advance, and contains international Islamic Sukuks in US dollars and cash in Bahraini dinars.

The duration of the Wakalah is overnight & one week and is available for retail Islamic banks every Tuesday.

The Wakalah expected profit rates are decided by the Monetary Policy Committee at the CBB.

The Wakalah expected profit rates are posted on a daily basis on the CBB website and are also available in the Reuters and Bloomberg information service on its CBB page (which Reuters and Bloomberg users can find by entering the code ‘CBOB’).

Wakalah Mechanism

  • The CBB announces the Wakil offer on its pages on Reuters and Bloomberg.
  • The offer will contain the issue/maturity date and the expected profit.
  • Banks wishing to participate, will send the CBB an acceptance to the offer
  • The CBB will invest part of the received funds in a portfolio containing Sharia compliant Sukuks and the other part will be kept in cash.

On the maturity date, the CBB will return the funds to the banks, plus the earned profit, less the transaction fees.

Reserve Requirements

All retail banks operating in the Kingdom of Bahrain are required to maintain reserves deposited at the CBB amounting to 5% of the value of non-bank deposits denominated in Bahraini dinars. The CBB determines from time to time the amount and form of the reserves through its Monetary Policy Committee. The reserves are not remunerated. The required reserves are held at specific reserve accounts at the CBB and cannot be used for other purposes. The reserve requirement system contributes to adjust the CBB’s structural liquidity situation vis-à-vis the banking sector.

The reserve requirement of each retail bank is calculated by the CBB on a monthly basis, from data provided by the banks at the end of the previous month. The CBB administers the necessary fund transfers between the retail banks’ clearing account and reserve account in order to ensure that the 5% requirement is maintained at all times.

FX Swap Facility

The Central Bank of Bahrain (“CBB”) first introduced the FX Swap Facility in 2008 to ensure a smooth and effective functioning of the money market in Bahrain. The CBB offers the facility to all licensed retail banks which hold BHD accounts with the CBB. The facility allows eligible counterparties to offer US Dollars against Bahraini Dinars at the request of the counterparties on all business days. The CBB currently offers various tenors: one week, one month, three months, six months, and one year. Updates on changes to the swap points are available on CBB’s pages on both Bloomberg and Reuters.

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