Rethinking the Weak Monetary Policy Transmission in The Gambia: The Role of the Financial System

1.  Introduction

Over the years the responsibility of stabilization policy have increasingly been place on the shoulders of central banks. However,  for central banks to deliver on this mandate their monetary policy instruments--primarily short-term interest rate--must be effective in influencing aggregate demand. This implies that stabilization policy are bet or gambled on whether central bank instruments are able to affect aggregate demand or not. If monetary transmission is weak or unreliable, the consequences could ripple across the economy. As argued by Mishra and Montiel (2012) “weak and unreliable monetary transmission would suggest restraint in the use of monetary policy, implying that placing primary responsibility for domestic macroeconomic stabilization on central banks may be misguided.”[1] Therefore, this follow-up blog to my article “Why Inflation in The Gambia is a Structural Phenomenon, Not Monetary,” aims to explain the monetary policy transmission mechanism and why its might be weak, unreliable or non-existent in The Gambia. Additionally, it also explores why the monetary transmission may remian weak even under the assumption that inflation in The Gambia is a monetary phenomenon.

3.0 Monetary Policy Transmission

Monetary policy in advance economies is asummed to affect aggregate demand via four main channels: the interest rate channel, the asset channel, the credit channel, and the exchange rate channel. However, considering the structure of The Gambia’s financial system, the monetary transmission is expected to differ from the advanced economies. This is evidenced by The Gambia’s lack of well-functioning markets for fixed-income securities, equities, and real estate as well as the limited integration with private international capital markets (for international capital mobility) and substantial central bank intervention in the foreign exchange market. This left The Gambia with only one probable channel for monetary policy transmission, the bank lending channel, because the other channels are likely to be weak and unreliable due to a bank dominant financial intermediaries, representing about 90% of the total asset of the financial sector.

In such cases where bank lending is the dominant channel, the effectiveness and reliability of monetary transmission largely depends on certain properties. As highlighted by Mirsha and Montiel (2012) the properties are based on the feedback causal relationship between monetary policy action and aggregate demand: (i) between monetary policy actions and the availability and cost of bank credit (ii) between the availability and cost of bank credit and aggregate demand. The lending channel which is the only viable channel for monetary transmission in The Gambia is also rendered weak, and ineffective due to the following factors:[2]

• The Gambia’s banking industry lacks competitiveness, causing changes in interest rate to impact the profit margins of banks, instead of the supply of bank loans. This limited competition is largely driven by high concentration, with three banks controlling about 55% of the industry. Furthermore, the government’s borrowing appetite has incentivized banks to prioritize risk-free government securities (T-bills) instead of maturity transformation, thus further limiting credit availability to the private sector.
• Due to the small size of the banking sector, a larger part of the economy does not interact with it. Thus, any monetary policy action on the banking sector would tend to exhibit weaker effects on aggregate demand. This can be explained by the low banking sector asset to GDP which stood at 59% in 2024, significantly lower than the range of 100% to 300% average in advanced economies. Interestingly, credit to private sector remian exceptionally low at just 9% of GDP, relative to deposit-to-GDP ratio of 39% in 2024. This highlights the limited role of banks in financing economic activity, further weakening the effectiveness of monetary transmission.
• The cost of lending increases due to weak institutional environment, causing banks to limit lending activity, thereby reducing the effectiveness of monetary policy on loan supply. This challenging operating environment is impaired by various bottlenecks including the absence of a well-functioning credit reference bureau, which exacerbate information asymmetry and credit risk, leading to an increase in the cost of lending. Furthermore, poor legal enforcement and absence of commercial court, make it difficult for banks to recover loans in case of default.

The above arguments explains the reasons for the weak monetary polcy transmission in The Gambia and are also supported by the argument of (Joof, 2025), who highlighted that “inflation in The Gambia continues to increase even during episodes of low money growth and that short-term interest rate do not proportionally react to an increase in the monetary policy rate. Thus, suggesting weak or unreliable monetary policy transmission”.[3]

4.0 Options

Even if we assume that inflation in The Gambia is a monetary phenomenon, the current structure of the financial system does not support effective monetary policy transmission. Therefore, strengthening the financial system should be a priority to improve the effectiveness of monetary transmission.

• CBG should focus on development of financial markets and financial institutions based on: “. . . depth (size and liquidity), access (ability of individuals and firms to access financial services) and efficiency (ability of institutions to provide financial services at low cost with sustainable revenues and the level of capital market activities)”.[4]
• Given the weak and unreliable monetary transmission, CBG should restraint in the use of monetary policy activism or activist (limit the use of policy tools to respond to economic fluctuations by adjusting interest rates, money supply, or credit conditions). This is because “monetary policy operates with long and variable lags,"[5] suggesting that the impacts of policy actions take time to materialize and are unpredictable. Because of these delays, monetary policy activist risk being pro-cyclical—tightening when the economy is already slowing or easing when inflation is rising—ultimately destabilizing the economy instead of stabilizing it.
• Due to the weak monetary transmission, CBG should avoid the adoption of a framework that involve public announcement of its objectives-such as inflation targeting regime. Doing so could risk its credibility, given the high likelihood of failing to meet its targets amid the uncertainties surrounding monetary transmission.
• CBG should use monetary rate as a signaling tool rather than a direct inflation-fighting mechanism (Joof, 2025)