The study aimed at investigating how the interbank market affects the monetary policy transmission mechanism in Malawi. To achieve that, the study analysed the nature of the relationship between excess reserves and the interbank market rate and tried to discuss other possible factors that affect the interbank market rates in Malawi and limit the effectiveness of the central bank’s efforts that aim at influencing important interest rates in the economy. The study further analysed the strength and speed at which the interbank market rate affects other money market rates, specifically the lending rate. Using financial markets monthly data for the period 2010:1 to 2018:6, the study applied Ordinary Least Square methods for estimation using Error Correction Model. From the results of the study, it is concluded that the interbank market is the right platform through which the central bank can influence money market rates in the process of monetary policy implementation. Interbank market rates respond to levels of banking system liquidity at a speed that makes sense for monetary policy and they are able to send significant signals to other relevant market rates like lending rates. Drawing from these outcomes, the study recommends continued forecasting and controlling of banking system liquidity by the central bank and establishment of additional factors that affect the interbank market rate and hence limit the central bank’s efforts. For further improvement in the monetary policy transmission mechanism, the study recommends increased knowledge on interbank pricing models for individual commercial banks and research on the informal sector’s reaction to central bank’s policy actions.
