The first meeting of 2024 is today and tomorrow. This is when it decides whether to lower the OPR, raise it or keep it at 3%.

The rate was raised from 2.75% to 3% on May 3, 2023 and has not been changed since then.

The factors that will influence the committee’s decision are inflation, employment figures and the global economic conditions.

Financial institutions adjust their interest rates for loans and deposits based on the OPR. These rates indicate the cost of borrowings and returns on deposits.

Many may have heard of the OPR but few understand it and the impact it has on our life.

What is the OPR?

The OPR is defined as the interest rate banks charge each other for funds lent overnight.

“If a bank needs liquidity, or cash, urgently it borrows from another bank and the rate of interest charged is the OPR,” economist Carmelo Ferlito, who is CEO of the research house Center for Market Education, told FMT Business.

Liquidity enables banks to manage their daily transactions, from deposits to withdrawals, seamlessly.

If there is a sudden surge in withdrawals, the liquidity ensures there is sufficient cash to go around. It’s much like a piggy bank for a rainy day.

To maintain stability and liquidity in the banking system, banks with extra cash lend to others facing a shortfall. This ensures a balanced distribution of liquidity, crucial for the smooth functioning of the financial system.

Apart from being a reference for banks, the OPR also has an impact on daily life in ways that matter to the average person.

Inflation control

The OPR is an important device in BNM’s toolbox to manage inflation and ensure price stability.

Economist Firdausi Suffian of UiTM Sabah likens it to a thermostat. It is adjusted up or down based on whether the economy is “overheating” or “cooling”.

He said excessive spending creates increased demand for goods, raising inflation to “unhealthy” levels. This pushes prices up as businesses seek to maximise profits.

When the economy “overheats” with high inflation, BNM may raise the OPR to discourage spending so it cools down the economy.

When interest rates rise, people are less inclined to make big purchases given that they have to pay more to borrow money for a mortgage, car loan or investment.

For businesses, borrowing to expand, invest or just to run daily operations becomes more costly. That reduces profitability, forcing them to scale back their plans.

This leads to lower investments, fewer job opportunities and slower economic growth.

Higher interest rates can thus make alternative investments more attractive. Investors may earn better returns by putting their money in savings accounts than take loans for business expansion.

Stimulating the economy

But just like a thermostat, the OPR cannot be set too high or too low. Finding a sweet spot is essential so the economy does not come to a standstill or spin out of control, Firdausi said.

In a depressed or low-activity economy, BNM lowers the OPR so banks can reduce lending rates.

Theoretically, this encourages businesses to borrow for investments, thus stimulating the economy.

However, setting the OPR too low is also counter-productive.

Ferlito said low interest rates could lead to households putting away more money rather than spending it to make up for reduced interest earnings for their long-term savings.

He said an OPR that is too low can also lead to the formation of asset bubbles as investors seek higher returns by investing in assets such as real estate or stocks.

This increased demand can drive up the prices of these assets to unrealistic or unaffordable levels.

But when the rush to buy these assets stops, prices drop significantly.

Ferlito said low interest rates were what created the 2001 dotcom bubble and the 2008 asset bubble.

Why should people care?

The average person should pay attention to changes in the OPR given their impact on the economy beyond lending rates.

For instance, Firdausi said, a high OPR could affect job seekers as businesses scale back expansion in response to elevated interest rates.

Given the OPR’s close link to inflation, it is crucial for everyone to monitor changes as it also has an impact on the cost of living.

Loan repayments for big ticket items such as cars and houses are also affected as their interest rates are typically aligned with the OPR.

For Ferlito, the average person should also be vigilant during extended periods of low interest rates as it could signal an asset bubble that could eventually lead to a financial crisis.