Central banks in developing economies have mastered a form of financial alchemy that largely escapes public scrutiny. They introduce refinance schemes for agriculture, SMEs, exports, or green projects at concessional rates of 2% to 4% when prevailing market rates range between 9% and 12%. Commercial banks eagerly access these funds, lend at higher rates, and enjoy comfortable spreads. Governments celebrate targeted credit support, and the narrative of ‘development finance’ gains traction. Yet beneath this seemingly virtuous mechanism lies a deeper reality: money is created out of nothing, and the resulting ‘income’ is ultimately paid for by the public in invisible ways.
When a central bank refinances a commercial bank, it does not draw from tax revenue, retained earnings, or public deposits. It simply credits the reserve account of the bank with newly created digital money. No saver deferred consumption to fund this loan. No prior production generated this purchasing power. It is created ex nihilo – through balance sheet expansion by keystroke. At that moment, there are no additional goods or services in the economy to match the new money. Commercial banks then lend these funds onward at higher rates, earning spreads for acting as intermediaries. The central bank, in turn, books interest income on an asset that cost nothing to create. Both institutions report profits. But these are accounting gains detached from real economic production. At inception, the economy has only more money, not more goods.
In practice, however, outcomes often diverge. In many developing economies, refinance is directed toward politically prioritised sectors rather than economically viable projects. Funds frequently flow into import trading, land speculation, or the evergreening of weak loans. In such cases, new money chases existing assets rather than creating new output. The consequences are predictable: inflation, asset bubbles, and pressure on the exchange rate. Because refinance operates outside the fiscal budget, its costs remain obscured. No parliamentary approval is required. No explicit allocation appears in national accounts. The burden instead manifests indirectly through rising prices, currency depreciation, and financial instability. The public pays, but without visibility.
If the objective is to provide affordable credit to priority sectors, a more transparent mechanism exists. Banks should lend at market-determined rates that reflect deposit costs, operating expenses, and credit risk. If policymakers wish to reduce borrowing costs – for example, from 10% to 4% – the difference should be covered through a direct interest subsidy. The government or central bank can reimburse the lending bank for the gap.
The political appeal of refinance lies precisely in its opacity. A finance minister proposing a large subsidy programme must defend it publicly. A central bank launching a refinance facility receives praise for supporting growth without appearing to spend. Credit expands, balance sheets grow, and the illusion of costless support persists – until macroeconomic consequences emerge.
A similar dynamic exists within central banks themselves through subsidised staff lending. Employees often receive housing, vehicle, or personal loans at rates far below market levels. The mechanics mirror refinance: money is created, lent at concessional rates, and interest income is recorded. A commercial bank could not sustain such lending without incurring losses, as it must pay for its funding. The central bank, however, faces no such constraint. If employee welfare is the objective, transparency again offers a better path. Competitive salaries or explicit interest subsidies would achieve the same goal while accurately reflecting personnel costs. The current system understates expenses, inflates reported profits, and normalises the idea that money creation can serve internal benefits.
While developing economies undeniably need affordable credit, they also require clarity about its cost. Refinance obscures three major economic burdens. First is the inflation tax. When money supply expands faster than output, prices rise. A farmer borrowing at 4% gains little if input costs – fertiliser, fuel, equipment – rise by 8%. The nominal rate becomes irrelevant; the real cost remains high. Second is misallocation of capital. Refinance programmes often come with eligibility criteria and quotas, encouraging banks to lend according to regulatory classifications rather than economic viability. The result is inefficient investment, excess capacity, and weak repayment performance. Third is moral hazard. When banks expect that troubled loans can be refinanced or rolled over under new schemes, they have less incentive to assess risk rigorously.
A practical reform path would include several steps. Existing refinance schemes could be converted into transparent interest subsidy programmes with defined annual limits. Lending rates would be determined by the market, while subsidies would bridge the gap for targeted sectors. Banks would then have incentives to strengthen credit appraisal and risk management. Internal practices should also align with this principle. Subsidised staff loans could be replaced with market-based borrowing complemented by explicit allowances or subsidies recorded as expenses. This would improve transparency and accountability.
Perhaps most importantly, central banks should disclose the implicit costs embedded in current refinance operations. For instance, if funds are provided at 3% when market rates are 8%, the 5% gap represents a hidden transfer. Publishing such figures would reframe public debate from expanding refinance to evaluating whether the subsidy is justified.
The true cost eventually emerges through inflation, reduced purchasing power, exchange rate depreciation, or banking sector stress requiring recapitalisation. An explicit subsidy, by contrast, forces immediate recognition and democratic choice. It also protects savers. When banks access low-cost refinance while depositors receive modest returns, an implicit transfer occurs from savers to borrowers. Under a subsidy model, depositors earn market returns, borrowers benefit from reduced rates, and the difference is financed transparently through the budget.
The role of a central bank is not to function as a development agency. Its primary responsibility is to preserve the value of money and maintain macroeconomic stability. When it creates money for concessional lending, it introduces purchasing power before corresponding output exists. Economic development requires investment, but it also requires honesty about costs. Refinance obscures this reality by creating the illusion of costless support. Interest subsidies, though politically more difficult, align policy with transparency and accountability.
Until such reforms take place, refinance will remain a convenient illusion. It creates income without apparent cost, credit without visible sacrifice, and growth without explicit trade-offs. But like all illusions, it carries a hidden bill – paid not upfront, but through inflation, instability, and lost trust.
The writer is a liaison officer at a trade company
