Banks pass on rate hikes faster than cuts, IMF says

Nigeria’s banking sector is quick to pass higher interest rates on to borrowers but much slower to deliver relief when monetary policy eases, according to a new International Monetary Fund (IMF) assessment that sheds light on one of the most important channels through which monetary policy affects households and businesses.

The finding comes as Nigeria undergoes one of the most significant transformations of its monetary and foreign exchange framework in decades following the unification of the foreign exchange market in June 2023 and the subsequent transition to a floating exchange rate regime.

While much attention has focused on the impact of the reforms on the naira and inflation, the IMF says a critical but less discussed development is the changing way monetary policy is transmitted through the financial system and, ultimately, to consumers and businesses.

In a Selected Issues Paper accompanying its latest Article IV consultation on Nigeria, the Fund found that the effectiveness of interest rate transmission has improved considerably since the foreign exchange reforms. However, it also identified a significant asymmetry in how banks respond to changes in the Central Bank of Nigeria’s Monetary Policy Rate (MPR).

“Interest rate transmission displays a clear ‘rockets-and-feathers’ pattern, with borrowing rates adjusting upward rapidly during tightening cycles but declining only gradually when policy is eased,” the IMF said.

The implication is straightforward but important for businesses and households. When the Central Bank raises interest rates to combat inflation, banks respond quickly by increasing lending rates. But when the policy environment eventually shifts toward lower interest rates, borrowing costs do not fall at the same pace.

According to the IMF’s analysis, a 100-basis-point increase in the MPR raises Treasury bill and lending rates by roughly 175 to 180 basis points on impact. By contrast, an equivalent reduction in the policy rate lowers those rates by only about 25 to 30 basis points.

The Fund described the asymmetry as statistically significant and evidence that banks amplify monetary tightening while responding much more cautiously during easing cycles.

The finding comes after a period of aggressive monetary tightening by the Central Bank of Nigeria. Since the foreign exchange market reforms began in 2023, the MPR has been raised sharply to 27.5 percent as policymakers sought to contain inflation and stabilise expectations under a more market-determined exchange rate system.

The IMF noted that wholesale market rates and government securities have responded strongly to these policy moves. Treasury bill yields have climbed significantly, while lending rates across the banking system have adjusted higher, reflecting tighter financial conditions.

However, the report suggests that the burden of monetary tightening has fallen disproportionately on borrowers.

The asymmetry identified by the IMF means businesses seeking working capital, manufacturers financing expansion, and households accessing credit are likely to feel the effects of higher policy rates quickly. Yet they may not experience comparable benefits once monetary conditions begin to ease.

In September 2025, CBN cut its benchmark interest rate, known as the Monetary Policy Rate, by 50 basis points to 27 percent and further to 26.50 percent in February 2026.

The phenomenon is not unique to Nigeria, but the IMF’s findings indicate it has become particularly relevant as the country transitions to a more market-based monetary policy framework.

The report argues that understanding how interest rates move through the financial system has become increasingly important because exchange rate reforms have elevated the role of the MPR as a key policy signal.

Before the foreign exchange market unification, the effectiveness of monetary policy was often undermined by distortions created by multiple exchange rates and administrative controls.

For years, Nigeria operated under a framework where official exchange rates were tightly managed by the Central Bank while parallel market rates reflected underlying demand and supply conditions. The resulting distortions complicated monetary policy implementation and weakened the relationship between policy decisions and market interest rates.

The IMF noted that during the period classified as a managed arrangement between 2007 and 2016, monetary transmission existed but remained incomplete. Interbank and Treasury bill rates responded to policy changes, although not fully.

Conditions deteriorated further during the multiple exchange rate regime that followed.

According to the Fund, transmission “broke down entirely” between 2016 and 2023 as efforts to defend the exchange rate often conflicted with monetary policy objectives.

During that period, liquidity injections aimed at supporting the exchange rate frequently offset the impact of policy rate adjustments, reducing the ability of the MPR to influence financial conditions.

The June 2023 foreign exchange market reforms marked a turning point.

By unifying exchange rate windows and allowing the naira to move toward a market-determined level, policymakers removed a major source of distortion within the financial system.

The IMF said the reforms have helped restore the transmission mechanism linking Central Bank decisions to market interest rates.

The interbank call rate, which reflects short-term funding conditions in the banking system, now exhibits almost one-for-one pass-through from the MPR.

According to the report, the interbank rate responds nearly proportionally to changes in the policy rate, indicating that monetary policy signals are once again influencing short-term money market conditions.

Treasury bill yields have also become more responsive to policy adjustments.

Nevertheless, the transmission process remains incomplete.

One area where responsiveness remains weak is deposit rates.

The IMF found that while the MPR and money market rates have risen sharply, savings deposit rates have increased only modestly and remain largely within a range of 3 percent to 7 percent.

This means that while borrowers face rapidly rising lending costs, depositors have seen comparatively limited gains from higher interest rates.

The report notes that the average deposit rate displays weak responsiveness to policy changes and has remained muted across different exchange rate regimes.

The divergence between lending and deposit rates highlights one of the challenges facing Nigeria’s monetary policy framework.

For policymakers, effective transmission requires not only that borrowing costs respond to policy decisions but also that savings rates adjust in ways that influence financial behaviour and strengthen the role of the domestic currency.

The IMF argues that further reforms are needed to improve the transmission mechanism.

While acknowledging significant progress since exchange rate unification, the Fund said strengthening the operational framework would help ensure that the MPR more effectively anchors market interest rates.

“Aligning liquidity management operations with the policy stance will be critical to reinforce this transmission channel,” the report said.

The IMF also pointed to the banking sector’s 45 percent cash reserve ratio as an area that could eventually be streamlined as inflation declines and macroeconomic conditions improve.

According to the Fund, stronger confidence in the naira, supported by lower and more stable inflation, could increase demand for local currency and help reduce structural excess liquidity in the financial system.

Such developments would create conditions for a more efficient monetary policy framework and potentially support a gradual reduction in reserve requirements over time.

For now, however, the IMF’s findings suggest that Nigeria’s monetary transmission mechanism is operating more effectively than it did under the previous exchange rate regime, but not yet evenly.

The Central Bank’s policy signals are increasingly reaching financial markets and influencing borrowing costs. Yet the benefits and burdens of those adjustments are not distributed symmetrically.

As Nigeria continues its transition toward a more market-oriented monetary framework, the speed at which banks pass higher rates to borrowers, and the slower pace at which they reverse those increases, may remain one of the clearest indicators of how monetary policy is felt across the real economy.