Prepared by Dr. Ibrahim Rasool Hani Monetary policy is a set of actions and decisions undertaken by the central bank to achieve macroeconomic objectives, most notably price stability, economic growth, and financial stability. In Iraq, for example, monetary policy relies on “information-based or signaling rules” to generate stability in the financial and banking market, rather than direct intervention that may cause market distortions. The objectives of monetary policy include: • Preserving the purchasing power of the national currency. • Combating inflation and limiting its negative expectations. • Enhancing overall macroeconomic performance. • Improving the standard of living through maintaining financial system stability. Monetary Policy Instruments and Their Impact on Commercial Banks . Interest Rate (Policy Rate) The interest rate set by the central bank known as the policy rate is one of the most influential tools affecting the banking sector. In Iraq, this rate currently stands at 7.5%, directly influencing the cost of borrowing and lending within the banking sector. When the central bank raises the interest rate: • The cost of borrowing for commercial banks increases. • Lending capacity declines due to the higher cost of funds. • Profit margins may improve if banks are able to fully pass the increase on to borrowers. • Demand for loans from individuals and businesses decreases. Conversely, when the central bank lowers interest rates: • The cost of funds for banks decreases. • Demand for loans increases. • Profit margins may narrow if deposit rates do not decline at the same pace. . Required Reserve Ratio The required reserve ratio represents the portion of deposits that banks must hold at the central bank and cannot use for lending. In Iraq, this ratio is 18% for current deposits. Effects of changes in the reserve requirement: • Increasing the ratio: Reduces funds available for lending, limiting banks’ ability to generate interest income. • Decreasing the ratio: Increases liquidity available for lending, enhancing banks’ ability to expand credit. . Open Market Operations Open market operations involve the buying and selling of government securities by the central bank to influence liquidity in the banking system. Mechanism of impact: • Selling securities: Absorbs liquidity from the banking system, reducing banks’ lending capacity. • Purchasing securities: Injects additional liquidity into the system, enhancing banks’ ability to expand credit. . Exchange Rate Policy Exchange rate management policies play an important role in banking performance, especially in countries that heavily depend on imports or exports. Central bank interventions in the foreign exchange market affect: • The value of assets and liabilities denominated in foreign currency. • The cost of external financing. • Borrowers’ ability to repay foreign currency–denominated loans. Impact of Monetary Policy on Banking Performance Indicators Profitability A study examining the relationship between monetary policy and the financial performance of Jordanian commercial banks found a statistically significant relationship between monetary policy instruments and banks’ profitability indicators. Changes in interest rates affect: • Net interest margins (the difference between lending and deposit rates). • Interest income. • Non-interest income (such as service fees). Liquidity Monetary policy tools directly influence bank liquidity through: • Changes in the required reserve ratio. • Open market operations that alter the money supply. • Additional liquidity requirements during crises. Solvency Prudent monetary policies help maintain bank solvency by: • Regulating credit levels in the economy. • Preventing the formation of credit bubbles. • Providing emergency liquidity support mechanisms when needed.