Restricted 1 Workshop: Indirect Tools for Monetary Operations – Open Market Operations Jhuvesh Sobrun Monetary & Economic Department Research & Policy Analysis Bank for International Settlements (BIS) [email protected]Maputo, Mozambique 5 August 2009 The views expressed are those of the presenter and not necessarily those of the BIS
Direct and indirect instruments of monetary policy Reserve requirements Standing facilities Open Market Operations Liquidity supply & bank balance sheet Financial crisis - different stages Unconventional Monetary Policies Implications for Emerging markets
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Workshop: Indirect Tools for Monetary Operations – Open Market Operations
Jhuvesh SobrunMonetary & Economic DepartmentResearch & Policy AnalysisBank for International Settlements (BIS)[email protected]
Maputo, Mozambique5 August 2009
The views expressed are those of the presenter and not necessarily those of the BIS
Part I - Role of the Central Bank & Monetary Policy framework/scope
- Short-term interest rates as operating target: implications
- Rules-based instruments: direct instruments - advantages v/s disadvantages
- Market-based instruments: indirect instruments - Advantages over direct instruments - Transition from direct to indirect instruments: conditions & phases
-These are often supplemented by data on intermediate targets (money supply, inflation and exchange rate) for more visibility and timeliness (due to lags in transmission channels
(interest rate, credit, wealth, exchange
rate)
-Nowadays, most CBs rely on the money market to distribute liquidity among banks at market interest rates
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The scope of monetary policy
Nowadays, most CBs
conduct monetary policy via ST interest rates
Well-functioning money market
vital
as formation of interest rates in interbank
market constitutes 1st
step in transmission of monetary policy
to financial markets & real economy
Exchange rate targets
used by small open economies
(HK, SG)
Quantity targets
(monetary base) used in some less developed countries
Commonly-used operating target
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Implications of ST interest rates as operating target
Advantages:•
They signal
desired policy stance via the Policy Rate
•
↓
fluctuations in interest rates (pre-condition: transmission mostly through interest rates
and developed + efficient
interbank
markets)
•
Can be used for
Liquidity management operations
Liquidity management operations
are either:
•
Supportive
–
influence ONLY the specific market rate
targeted by policy to keep it consistent with the policy rate
•
Active
–
influence the specific market rate targeted by policy over and above the impact of the policy rate –also called Balance sheet policy (BSP)
•
BSP implementable
whatever
the prevailing interest rate level
Active liquidity management operations
influence asset prices, yields &
funding conditions => substantial ∆
in size, composition and risk profile
of the CB’s balance sheet (more details in Part II & III)
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Direct policy instruments (used in the good old times?)
Rules-based: CB has regulatory power to set or limit prices (interest rate) or quantities (credit)
Aimed at
balance sheet of banks
They are:
Interest rate controls
Bank-to-bank credit ceilings
Statutory liquidity ratios (hold % of bank’s liabilities as govt securities)
Directed credits
Bank-to-bank rediscount quotasUse of direct instruments – 1998 to 2004
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Case for direct instruments
Best or only possible solution when:•
information is
scarce (used to limit adverse selection)
•
bank supervision & legal structures weak•
financial markets underdeveloped or at
early stages of development
•
Low market participation•
transmission mechanism
of monetary policy is uncertain
Relatively easy to implement & explain
to politicians and the public
Low direct fiscal costs (Statutory liquidity ratios)
Easy to link with a monetary targeting policy
(BUT monetary targeting relies on strong & stable relationship
over time between demand for money and supply of
money –
not the case in reality)
CB can more easily control flow of credit to banks or targeted sectors
Supplemental instrument (to RRs) in transition periods
or severe financial crisis (help more distressed sectors)
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Case against direct instruments
Disintermediation (to circumvent them) => ↓
policy effectiveness
& ↑
evasion
Financial repression => ↓
bank-based savings & shifts from formal to
informal markets => Distortions
Discourage development of interbank markets & secondary markets for securities
Hamper & distort competition => ↑
costs
in resource allocation
Credit ceilings tend to ossify credit distribution & act as barrier to entry of new players
Over time, policies become less effective => multiplication of controls (↓
credibility) => complex, multi-tiered structures of interest rates and credit controls which make situation worse
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Indirect instruments of monetary policy
Market-based instruments: they ∆
supply of banks reserves at
market-related prices
CB
determines overall systemic liquidity and
market distributes it
Roots: CB as monopoly supplier of high-powered money (i.e, monetary base (M0),i.e, the MOST liquid
Voluntary (precautionary) reserves >0, if reserves are remunerated
Free bank reserves = net foreign assets + net lending to government + lending to banks + other items (net) – notes – required or contractual (voluntary) reserves – liquidity draining operations
Reserve money or
Base money or
Monetary Base
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Reserve requirements
Required reserves
(generally fixed by CB & binding (compulsory))•
Defined as requirement for a bank to hold minimum current account balances with
CB (usually a % of its unsecured cash deposits)
• Only INDIRECT
influence of ∆
interest rates
(i) on required reserves•
↑
i => ↓
demand for deposits
as economic activity slows down => ↓ the
base
used to calculate required reserves
•
Enforcement thru
penalty interest rate
(usually the lending SF rate) or restricted access
to CB lending facilities
Excess reserves
(non-binding; settlement + voluntary reserves)• Opportunity Cost: no interest return or banks earn interest < market rates•
Size
= fn (uncertainty on payment outflows (+), institutional characteristics of payment system (+ or -), expected costs of overdrafts (+), market interest rates (-), uncertainty about OMO (+), expensive standing facilities (+))• Higher excess reserves ↓
last day of the MP => binding RR ONLY on the last day of MP=> banks are indifferent between holding liquidity on different days of MP (before last day)
Averaging acts as Buffer
to stabilize cash flows & limit O/N int. rate volatility
Buffer effect more effective
if :
•
Longer MP•
RR binding enough
to affect marginal reserves demand
•
Combined with frontloading (ie, CB injects surplus liquidity early in the MP to mop up excess later on) => ↓
funding liquidity risk for banks
Contributes to ↓
excess reserves
by acting as an indirect liquidity injection
Critique:
By offering Greater flexibility => poorer liquidity mgt
=> prudential
issues
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Features of reserve requirements (cont.)
Reserve requirement with averaging Varying elasticity over maintenance period
Start of maintenance period
During maintenance period
End of maintenance period
Rmin
<= RR <= Rmax
Maximum elasticity of Reserves demand
Reserves demand still very elastic
Reserves demand inelastic
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Features of reserve requirements (cont.) Buffer function of reserves averaging
under calm market conditions
DT
= inverse aggregate demand for reserves; ST
= supply of reserves; R
= daily average RR
Flat part of DT
curve
(highly interest-elastic), ie, supply shocks do not affect ST interest rate =>
RR varies without affecting ST int
rate
Non-flat part of DT
curve
= reduced interest-elasticity of DT
“With averaging, before last day of MP” No averaging or “With averaging, last day of MP”
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Functions of reserve requirements
Buffer –
stabilize cash flows & limit O/N int. rate volatility
Liquidity management (when averaged & lagged) –
facilitate interbank settlements
Monetary control: as reserve market management tool
& built-in stabilizer
Unremunerated RR
=> Introduce a wedge
bet. SFd
and SFc
to discourage over- lending => ↓
too fast credit growth
-
not much used (tax => disintermediation)
Income source for CB
(if unremunerated or remuneration < market rates)
Supportive role for OMOs
(“crude”
liquidity draining/injection device)
Prudential instrument in developing countries –
ensure that banks have sufficient liquidity in case of withdrawal of deposits –
prevent bank runs
Provide “automaticity”
when financial markets shallow
(& secondary markets inexistent) competition still too poor
for more flexible operations (like OMOs)
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Main problems with reserve requirements
Unremunerated RR
=> tax on banking system => disintermediation
High RR
put banks under pressure
(penalty attached to non-fulfilment
& comparative disadvantage relative to non-banks)
IF liquidity uncertainty
↑, banks tighten targets on their daily accounts => weaken RR averaging
=> liquidity effects emerge on other days of MP
=>
“flat part”
of demand curve disappears
Blunt measure to control liquidity, esp. in the medium term:•
↓
RR when liquidity shortage: too low RR => buffering
effect too small to
be still significant•
↑
RR when liquidity surplus
=> high RR => ↑
tax on banking system (if
not remunerated) => cost of liquidity draining ultimately supported by the economy
•
Frequent changes in RR
=> disruptive
& ↑
costs for banks (may affect client rates on deposits/borrowings)
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Reserve requirements in selected countries
RR on FC
are actually maintained in local currency in most countries
Less developed countries do not remunerate excess reserves
– tax! => disintermediation
RRs
are much higher
-
income for CB Other indirect insts
less effective -
inexistent or shallow secondary markets
High RR with no remuneration
can be dangerous (disintermediation)
Averag-ing Carry-over Accounting MP
RR on domestic currency
RR on foreign
currency
Remuneration of excess reserves
China No No Lagged 10 days 0.1 0.04 YesIndia Yes No Lagged 2 weeks 0.06 0.06 Yes (for > 3%)Korea Yes No Half-lagged 1/2 month 0-7% 0-7% NoBrazil Yes No Lagged 2 weeks 0-45% 0-45% YesKenya 0.05 0.05 NoTanzania 0.1 0.1 NoMauritius Yes No 2 weeks 0.04 0.04 NoSouth Africa Yes 0.025 0.025 NoEurosystem Yes No Lagged 28-35 days 0.02 0.02 YesJapan Yes No Half-Lagged 1 month 0.05-1.3% 0.15-0.25% NoUK Yes No Lagged 1 MPC month Voluntary Yes (within + - 1%)US Yes Yes Lagged 2 weeks 0-10% NoSource: Central Banks.
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Conclusion to Part IRules-based instruments
(=> disintermediation, distortions in the
allocation of bank resources and loss of effectiveness by the monetary authorities) incompatible
with today’s developed financial markets,
international trade and and
liberalised
capital markets.
Reserve requirements, when averaging
is possible, are a good but not best way
to smooth
fluctuations in short-term interest rates, and by
spillover, to the rest of the yield curve. Their effects are however not clear over the medium-term.
Recommended for CB to use flexible, market-based
instruments of monetary policy that allow CB to control the supply of liquidity quickly and on day-to-day basis. This is best achieved through the combined use of standing facilities and discretionary monetary operations….
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Part II - Liquidity supply & CB balance sheet
- Autonomous factors & importance of liquidity management - Problems with liquidity surpluses
- Standing Facilities - Definitions & uses - Credit and deposit facilities - Features (maturity, collaterization, eligible instruments) - Corridor system & stigma
- Discretionary monetary operations - Definitions & uses - Conduct & implementation - Types: primary & secondary market issuance, repos - Permanent v/s temporary liquidity injection/absorption - Features (maturity, frequency of operations, auction techniques) - Associated risk control measures
- Conclusion to Part II
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Supply of liquidity
Net supply of reserves or liquidity
influenced by:•
Autonomous factors, ie,
Uncontrollable changes to the CB’s balance
sheet NOT the result of its domestic liquidity operations•
Policy factors
– its controllable
domestic liquidity operations
A Central Bank’s Balance sheetAssets Liabilities
Net foreign assetsNet securities
•
Outright•
Under repo
Lending to banksCredit to governmentOther items net
CurrencyBank reserves
•
Required reserves•
Excess reserves
Government depositsLiquidity draining operationsCapital and reserves
Autonomous liquidity position
= net sum of autonomous factors
=
Net foreign assets +
Credit to Government
+
Other net assets–
Government
deposits
–
Currency
Net policy position (+ means inject, -
means withdraw)=
Bank reserves –
Autonomous liquidity position
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Importance of liquidity management
Good liquidity forecasting smooth undesirable liquidity fluctuations -
vital for efficiency
of OMO and SFs
By adjusting level of reserves balances, CB can offset or support
permanent, seasonal or cyclical shifts
in supply of reserve balances => effect on ST interest
rates &
rest of yield curve
Excess liquidity => ST int. rates ↓•
if ST interest rates too low, banks tempted to make riskier loans in search of yield
or refuse to take customer interest-bearing deposits => ↓
savings,↑
consumption & ↑
inflation
If liquidity level ∆
a lot => ST interest rate volatility
↑
=> this impedes on devlt
of LT end of mkt
=> risk-aversion ↑
& banks reluctant to take positions
Both shortage & surplus liquidity
=> weak secondary market
for securities
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CB as LOLR & liquidity surplus
Liquidity surplus
usually characterised
by:•
Large amounts of OMO & SF liabilities, but little or no OMO & SF lending
•
Excess reserves
in banks’
current accounts•
↓
ST interest rates
( => ↑
inflation)
•
Weakening exchange rate
(if speculating banks seek higher FX returns or think that domestic inflation will rise soon)
Central Bank’s Balance sheet
Assets LiabilitiesNet FX reservesNet lending to govtLending to banks
•
OMO•
SFsLOLR & lending to
“priority” sectorsOther items
Currency in circulationReserve requirements (RR)Banks’ current accts excl. RRDeposits, CB bills (OMO)Deposits (SFs)Capital & ReservesOther items
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Why is structural liquidity SURPLUS not preferable?
Often used as the remuneration rate on remunerated excess RR
Frontloading (ECB since Aug 2007) => liquidity surplus at beginning of MP => ↑ use of SFd; ECB (1st
week Oct 08: daily avg
use of SFd
went from 1.5 bil
euros to 43 bil
euros)
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Standing facilities (SF) – cont.
Sometimes, Credit available at subsidised rates, ie, SFc < Market rates•
May lead to
Speculation on devaluation of LC =>
banks borrow funds (via
SFc) to purchase FX from CB, betting on speculative profits after devaluation •
May need additional supportive measures: rationing & CB close scrutiny
Types of eligible instruments•
Short-term, mainly O/N (loans/deposits; repos/reverse repos, FX swaps, outright sales/purchases of short-term securities or FX)
•
Recent trends marked by broadening of eligible instruments
Maturity of SFs•
O/N in most countries
–
serves “safety-valve”
function
•
Recent trends
(financial crisis): ↑
maturity to ↓
rollover risks
in interbank markets
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Standing facilities (SF) – cont.Quick overview of money market instruments & their uses
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Collaterisation of SFs: floors & ceilings
Hard floor:
(no collateral needed) => SFd
available to all banks without any limit => (SFd
< O/N rate)
Soft ceiling:
collateral needed for SFc
=> banks with non-eligible collateral forced to borrow from the market => may cause market rates to ↑=> (SFc
< = O/N rate) –
may pose problems during financial crises
Physical location of collateral
important as rapid access & transfer needed
– many SF settlements are “same-day”
Use of collateral denominated in foreign currencies
=> micro-
and macro- prudential
implications for > 1 country –
need international cooperation
Recent trends
(financial crisis): broadening range
of eligible collateral and wider set of counterparties
to facilitate effective distribution of CB funds
=> changes portfolio composition of CB’s balance sheet=> CB more exposed to illiquid assets –
risk control measures to protect
CB’s balance sheet against financial risks (haircuts, etc)
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The Corridor Approach (SFc – SFd)
Provides automaticity -
CB can deal at both upper & lower bound
Narrow corridor•
Use of SFd
more attractive
v/s
interbank
market for excess liquidity depositing
•
Minimises
interest rate volatility; best if stigma low or zero => ↓
need for further fine-tuning operations
•
Serves the rate-setting or rate-stabilising
function•
Implies higher
importance of RR averaging
to contain rates within bounds
•
Too narrow
=> ↓
incentive for banks to manage their liquidity via interbank market & hamper its development
•
Too narrow => moral hazard (no penalty) => over-reliance•
Necessary
in financial crises
with severely impaired interbank
funding markets
Wide corridor•
Safety valve: prob
(market rates under-/over-shooting SF rates) ↓
•
Encourage banks to fund themselves via interbank
market instead of CB•
More room for interest rate volatility
=> ↑
need of fine-tuning operations
•
=> Lower use of SF
as spreads between SFc
and market rates ↑=> ↑
holdings of voluntary reserves
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Stigma negatively affects the effectiveness of SFs
Banks go to interbank
market even if more costly
than to use SFs
External: borrowing from CB is an adverse signal
about creditworthiness as SFs
tend be associated with Emergency Liquidity (eg, US)
Internal: if CB credit requires additional administrative procedures
as SF seen as deviation from normal routine
High stigma & narrow corridor => ↑
prob
market rates under-/over-shooting SF rates
Important for CB to communicate its actions clearly (eg, announcements about liquidity operations should be separated from those about policy rate) => ↓
stigma => SFs
more effective
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As of March 2007 Lending SF Deposit SF Ceiling Floor
Euro area Repo
or collaterised
credit Deposit Policy rate + 75 bp
(since 13/05/09)
Policy rate -
75bp (since 13/05/09)
Indonesia Repo Deposit Policy rate + 300 bp Policy rate -
500 bpMalaysia Repo
or collaterised
credit Direct borrowing Policy rate + 25 bp Policy rate -
25bp
New Zealand Repo Deposit Policy rate + 50 bp Policy rate
Prudent fiscal policy: conflicts with debt management goals•
Monetary policy MUST be insulated
from deficit financing & needs fiscal
discipline
on the part of the government to be effective
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Types of discretionary monetary operations
Open Market-Type Operations (OMO-type) •
Issuance of CB paper
or government securities
in primary market => this
absorbs excess liquidity•
Direct borrowing/lending in interbank
market with underlying assets as
collateral: eg, auctioning CB credit => this injects liquidity•
Difference with SFs
which are at initiative of banking system
(not CB)
•
Transfer
of fixed-term public entity
deposits
Open Market Operations (OMO)•
Outright
purchases/sales of domestic currency assets in secondary market
→
permanent (sales = excess liquidity absorption)•
Reversed
purchases/sales of domestic currency
assets (repos
and reverse
repos) & foreign currency
assets (FX swaps) →
temporary (purchases = liquidity injection)
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Primary market issuance of CB paper & Govt. securities
Risk-free => highly sought-after; Issuance to withdraw excess liquidity
Most commonly-used OMO in developing countries
and at initial transition stages
to use of indirect instruments –
foundation for secondary markets
Rough-tuning liquidity management•
Securities issued tend to have long maturities
=> not suitable for ST
interest-rate setting•
Banks may bid for liquidity management reasons not in line with CB’s plans
Issuance of CB paper •
↑
CB independence•
but in case of loss, may ultimately => ↓
CB independence
•
Used when:•
separation needed
bet. Monetary & fiscal policy goals
•
CB more creditworthy
than government or govt securities not available •
Coordination
with Treasury needed to protect CB independence
•
May be detrimental to development of active govt securities market
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Primary market issuance of CB paper & Govt. securities (cont)
Issuing government securities-
coordination with govt debt manager necessary as govt securities also used in fiscal policy•
Reserve neutral: CB reinvests
proceeds of maturing securities into new
securities•
Reserve draining: CB redeems
maturing securities
Coordination with government debt issuance•
1 possible coordination solution: govt issues for structural liquidity purposes & CB for temporary liquidity purposes, with pre-agreed limits
•
If CB engages on LT structural issuance, advanced planning
rather than ad-hoc better (avoid uncertainties & disruptions)
•
Makes sense to harmonise securities’
specification
(same registry, discount yield, collateral, etc)
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Open Market Operations (OMO): Secondary market operations
More flexible
and larger choice
of operations/instruments than primary market operations•
permanent (outright sales/purchases of securities & foreign exchange)
•
temporary (repos/reverse repos, FX swaps, deposits & collaterised
lending)•
Final impact on liquidity depends on
depth
of secondary market & CB has to
have adequate stock of marketable assets
Even If No govt
securities
available or held by LT investors => secondary mkts still allow CB to carry out OMOs
by using private sector paper, CB bills and FC
Permanent operations: best for basic/structural liquidity
needs & if CB seeks to impact on market price of specific asset
=> permanent ∆
in reserve balances
Outright transactions: assets are bought or sold up to their maturity•
May hinder market development when secondary market thin
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Open Market Operations (OMO): Secondary market operations (cont.)
Foreign exchange outright transactions•
Widely used in developing & transition economies
•
Problem: spillover
effects
=> better use repos
of FX swaps instead•
In dollarised
countries: FX transactions (permanent) may affect exchange
rate while FX swaps
will not•
CB more exposed to settlement risk
Temporary operations
(reversible and more flexible): best for fine-tuning & if CB does not want to influence market price of specific asset
Collateral in reversed operations•
CBs tend to accept long lists of collateral
to avoid endangering monetary
policy => risk control measures needed
(more later)
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Repurchase agreements (repos)
Defined as ST collaterised
loans
(usually < 2 weeks & often O/N) arranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date => no aggregate impact on price of individual securities
Good for offsetting seasonal/cyclical fluctuations
& when immediacy of response necessary
Play crucial role in reallocation of liquidity among banks
(during normal times)
Act as a safety net for smoothing interbank
cashflows
(in turbulent times)
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Liquidity management options for the CB
Permanent Liquidity Shortage (Surplus)•
Buy CB bills or government securities
before they expire in the primary
market (issue new government securities or CB bills)•
Outright purchase
(sale) of foreign exchange
in the secondary market
Temporary Liquidity Shortage (Surplus)•
Provide short-term collaterised
loans (SFc)
to banks (invite banks to deposit
short-term remunerated deposits; SFd)•
Purchase
(sell) short-dated outright bills or foreign exchange
•
Offer repo
(reverse repo) transactions where the CB BUYS
(SELLS) securities from banks
•
Purchase (sell)
FX from banks
and sells (buys) domestic currency to swap them at a specified price at a given date (FX swaps) in the near
future
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Maturity of discretionary monetary instruments
Short-term
operations best if CB wants to affect ST interest rates or
the exchange rate and help liquidity management (market needs cash!)
Long-term
operations best (outright transactions) if CB wishes to
adjust market’s structural liquidity position
LT operations not suitable to influence interest rates, as they can:•
Dilute the impact of monetary policy decisions
•
=> speculation•
Confuse the yield curve
•
=> pivoting, i.e, ST rates ↓
=> distortions in yield curve•
if CB wants to drain liquidity => banks reluctant to participate
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Frequency: Regular and irregular operations
Regular (Eg: ECB’s
MROs
& LTROs)
•
Operations conducted according to an indicative calendar•
Steer interest rates & signal policy stance
•
Function of
: Reserve averaging, OMO maturity, volatility & size of flows of autonomous factors v/s
size of RR, CB’s commitment to interest rate
stability•
Eg: ECB: weekly Main Refinancing Operations (MRO)
Irregular: at short notice
& to react to unexpected shocks, with usually
much smaller group of banks
(sometimes 1-to-1)•
Operations much faster than regular OMO; eg, fine-tuning operations
•
To smooth effects on interest rates
caused by unexpected liquidity ƥ
No standardised
maturity; no indicative calendar
•
Freq of use has ↑
significantly during recent financial crisis
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Frequency: Regular and irregular operations (cont.)
Frontloading and fine-tuning operations (FTOs) during the MP•
Frontloading: CB allots above benchmark
(creates surplus liquidity) at
beginning of MP
& gradually withdraws surplus until end of MP.•
Goal: generate expectations of interest target close to Policy rate
on last day
of MP
because:•
↓
prob
(banks would have to borrow in unsecured market at high rates if
they cannot use SFs)•
↑
prob
(banks fulfill their RR early in the MP)
•
Problem: more volatility of ST interest rates on other days of MP
Problems with irregular bilateral operations•
May not be visible, equitable and not distribute liquidity efficiently
•
Signaling effect: 1 counterparty knows about the CB’s actions –
competitive advantage over other banks who might be less willing to participate
as they
judge situation unfair
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Auction techniques
All discretionary monetary operations are conducted via auctions
Standard tenders•
Regular; publicly announced
by means of wire services; eg
ECB’s
MRO &
LTRO
Quick tenders•
Irregular; fine-tuning; little counterparties; may not be announced publicly in advance
Most auctions characterized by allotment uncertainty; exception = full allotment tenders (ECB since Oct 2008)
Fixed rate or Volume tenders•
CB acts as signal receiver
•
banks bid only for volumes
supplied by CB at a pre-set interest rate•
If the aggregate amount bids received exceeds total amount of liquidity to be allotted, submitted bids satisfied pro-rata
•
=> overbidding by banks which expect their bids to be pro-rated
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Auction techniques (cont.)
Variable rate or Interest rate tenders (Eg: ECB’s
weekly MROs)•
CB acts as signal transmitter
•
banks bid for amount and rate.•
CB charges the rates offered
(multiple-rate auction) or the cutoff rate
(single-rate auction). •
Bids listed in descending order of offered interest rates. Bids with
highest
interest rate levels are
satisfied first
Single rate auction (Dutch auction)•
Same rate
applied for all successful bids –
the
last winning offer’s rate
becomes the current interest rate of auction•
Allotment interest rate commonly called the stop-out rate
Multiple rate auction (American auction),•
Allotment interest rate is equal to the interest rate offered for each individual bid => different rates
on allotted bids
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Auction techniques (cont.)
Bid-to-cover ratio: number of bids accepted
/ number of bids that were properly submitted
in relation to the auction
•
Gauge of the current level of desirability
for the issue auctioned •
High ratio
=> high level of investor desire for the issue => high likelihood
that another similar auction would have good results•
In a full allotment tender
(eg, ECB since Oct 08) => ratio =1
•
Feature of full allotment tender: aggregate liquidity purely demand-driven (no longer determined by CB)
Initial margins (used frequently with reversed transactions)•
Initial Margin = a % of the theoretical value of underlying assets
•
Counterparties have to provide underlying assets with a value >=
to liquidity provided by the CB + value of the initial margin
Risk control measures with SFs & discretionary monetary operations
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Risk control measures with SFs & discretionary monetary operations
Valuation haircuts•
Underlying asset value = market value of asset -
a certain % (haircut)
Variation margins (used for marking-to-market)•
haircut-adjusted market value of underlying assets
used in liquidity-
providing reverse transactions have to be maintained over time, via margin calls
Valuation markdown•
CB applies a reduction of the theoretical market value of the assets
by
a certain % before applying any valuation haircut
Separate tranches of OMO for different classes of collateral (Fed)
Limits in relation to issuers/debtors or guarantors and Exclusion•
To mitigate correlation risks
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Use of discretionary operations in selected countries (up to March 2007)
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Conclusion to Part IIToday, most CBs use some sort of OMO and to a lesser extent SFs
in the
conduct of monetary policy. Differences are more on type & maturity of instruments used, collateral used and frequency of operations. These are influenced by the regime, the economic structure & openness, degree of development of primary and secondary markets for securities, credibility & independence of the CB
as well as its’
expertise in managing liquidity
and
the accuracy of its’
liquidity forecasts.
The current financial crisis
has shown that having highly developed & liberalised
interbank
markets and being able to use all sorts of instruments of
monetary policy available do not guarantee success. Enforcement
through regulation and cooperation with government debt management
policy are
crucial, together with the need for the CB to make good forecasts of autonomous factors
and take necessary measures early enough to counter
any adverse shocks…
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Part III
Financial crisis development stages
Major CB operations in advanced countries
Unconventional Monetary Policies (UMP)
Effects on Emerging markets
Effects on African countries
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Main features of the current financial crisis
Unprecedented
in its global reach
(main difference with past banking crises) and Reactions of CBs
(monetary policy easing to provide ample liquidity) & by
govts
(fiscal stimulus and bank rescue packages)
Consequences:•
Many advanced economies CBs have used up the usual tools of mon
pol
(like policy rate cuts (cut to almost 0 in US & UK)) –
had to resort to unconventional monetary policies
to provide liquidity => huge ↑
in size of
balance sheets & ∆
in composition
(=> ↑
risks of losses for CB)•
Government interventions
to restore confidence in banking systems &
safeguard flows of credit have affected public finances & raised
questions on their sustainability => large ↑
in sovereign credit risk, fiscal debt &
deficits
Exit strategies
(timing & scale), adequate
legal & institutional frameworks, disclosure of information by involved parties
& differentiated resolution (to
minimize moral hazard) VITAL
for success of interventions•
Success => direct effect on confidence & future credibility of policies
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Development of the crisis (Aug 07 to mid-July 2009)Stage 1 (8/07 – 3/08): funding liquidity shortage, bank losses & writedowns
US subprime
mortgage problems=> Loss of confidence & investor retrenchment => ↑
=> big pricing differences across capital structure => ↑
sovereign CDS spreads
Fiscal stimulus
plans to stimulate demand & growth
Stage 5 (since mid-March 09): signs of improving situation
Unprecedented policy actions =>
stabilization of financial conditions & ↓
in systemic risks
↑
optimism; ↓
volatility; ↑
asset prices; ↓
LT ylds; equity prices ↑
=> ↓
Libor-OIS spreads & CDS spreads
Lending conditions still very tight, esp, cross-border lending
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Spreads, equity prices and distressed conditions
LF => large ↑
in Libor-OIS spreads, writedowns
& CDS spreads; big ↓
in equity pricesLF=> ↑
capital injections (esp. Q4 08 & Q1 09); ↑
govt
share in Q4 08
Deteriorating credit quality => ↑
writedowns
=> ↑
deleveraging
=> ↓
credit growthDomestic official support (=> ↑
Home bias) & FX swap market impairment =>
↓
cross-border funding => ↑
cross-border deleveraging
affecting EMEs
a lotConcern over fiscal sustainability & tight lending conditions =>
CDS spreads still higher
than pre-crisis levels
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Credit standards and bank loan growth
“Too”
accommodative conditions from 04 to mid-07 (negative)Severe liquidity hoarding but recently loosening lending conditions but still tight compared to pre-crisis periodSignificant slowdown in loan growth (US & XM) –
signs that confidence still wary &
after-effects of deleveraging
& home bias affecting cross-border lendingJP exception –
helped by cheap cost of capital (almost 0 interest rates)
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Volatility indicators
Significant ↓
in equity & exch
rate volatility after all-time highs after LF
(Sep 08); levels almost back to pre-crisis levels
Bond volatility still high => effects of aggressive government intervention (purchases of securities)
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Major CB operations to counter the crisis (industrial countries)
So far, 3 kinds of CB responses, by targeted objective:•
Achieve official stance of monetary policy (conventional liquidity easing)
•
Influence wholesale interbank
market
conditions (conventional liquidity easing, but unconventional in range & magnitude)
•
Influence credit market and broader financial conditions
(UMP)•
Credit (CE) –
growth of asset side of CB balance sheet
•
Quantitative easing (QE) –
growth of
liability side of CB balance sheet (∆ in bank reserves)
Emerging market exposure to spillover risks from advanced countries and CB balance sheet
EMEs’
dependence on advanced economies ↑
in recent years –
more exposed to spillover effects due to lower demand in advanced countries (=> falling prices and trade flows), liquidity hoarding, home bias, capital retrenchment (=>lower FDI), lower donor and remittance revenues
=> inject liquidity; OMO-type: US$ swaps or outright sales of FC to local banks to counter ↓
cross-border bank funding
Establishment of swap lines
with advanced country CBs for some EME CBs
International lending facilities
(IMF’s
Flexible Credit Line, modernization of conditionality & simplification of lending terms)
UMP: Directed private sector credit support (purchase of LT corp
bonds & deposit insurance schemes) => ↓
LT yields & ↑
confidence in local banks
Govt
support: guarantees to bank lending & spending on infrastructure (less on personal tax reliefs)
•
Problem: most packages currently programmed to wind down in 2010
& levels below model-based baseline scenarios
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Policy actions (cont)
Limited effects so far: still tepid flows into EME assets & severely strained funding & credit markets => deteriorating credit quality
EME CB balance sheets have not ↑
like those of advanced countries•
reflection of tighter constraints on EME liquidity easing
(higher external
vulnerability, shallower financial markets, conflicts between macroeconomic and systemic stability objectives, and less firm CB independence)
Firmer govt
commitments on fiscal stimulus needed
as EMEs
do not have extensive “automatic stabilizers”
like in advanced countries (like unemployment
insurance, etc)
Road ahead:•
More policy rate cuts & UMP
(liquidity injection & credit flow support measures)
•
more govt
commitment
to support banks & corporates
(for liquidity and credit needs), regulatory measures to facilitate creditor coordination
•
Rely less on exports
& promote domestic consumption/demand
while avoiding protectionist behaviors
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Characteristics of Sub-Saharan African financial markets
Shallow or undeveloped financial markets
(CBs do not have many alternative means
to counter liquidity squeezes) => significant exposure to counterparty
risk, lack of collateral, deficiencies in the payment system,
etc; this feature has also limited contagion thru interbank
markets & lower liquidity pressures
Substantial liquidity buffers: large share of T-Bills & other liquid assets in CB balance sheet
Certain direct instruments & RR
still widely used
compared to other indirect instruments & other regions
RRs
generally high, uniform across maturities & unremunerated
Differentiated RR ratios between LC & FC deposits
& Large share of FC deposits as % of total deposits => destabilizing shocks on the money multiplier are amplified => complicate CB liquidity management
High corruption, weak or non-existent CB independence
& Heavy reliance
on revenues from export of commodities & raw materials, remittances, donor funds & FDI
from developed countries governments
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Effect of the crisis on African countries (cont)
So far, pretty resilient-
limited integration with global fin markets, relatively high bank liquidity, low leverage & limited reliance on foreign funding
Like other EMEs,
Africa exposed to spillover effects of financial crisis to real economy
& deleveraging
from developed countries
Oil exporters &
financially more developed countries
hardest hit initially
Main concerns:
Tightening of global credit
=> Capital & FDI inflow, tourism, textiles & remittances revenues ↓; too thin domestic markets may not be able to accommodate demand for credit =>↑
credit & liquidity risks
Last hour:
Outlook slowing improving
(recovery in commodity prices & growth prospects + return of risk appetite =>resumption of foreign portfolio inflows) –
Africa will benefit from these with delays, though…
Risks remain:
confidence still fragile, weak bank balance sheets, lower than expected
global growth, constrained international bank lending & questions on
fiscal sustainability of public sector support & exit strategies adopted in developed countries that may have
adverse effects on EMEs
& Africa…
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Sub-Saharan Africa : easing monetary & fiscal policies
SSA countries have fewer & less effective policy instruments: fiscal multipliers are lower, financing constraints more binding, debt sustainability issues more pressing, monetary policy options limited by currency arrangements
Countercyclical monetary policies:
1st
half: high commodity prices => tightening of monetary policies
Since 2nd
half: ↓
commodity prices => loosening of monetary policies
Exchange rate depreciations may ↑
export-competitiveness, but may ↑
inflation
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Effect of the crisis on African countries
Less developed fin. markets
=> delayed crisis effects
via ↓
commodity prices, liquidity hoarding & capital repatriation by foreign banks & investors
↓
in commodity prices
& demand and lower capital
& FDI and remittances
=> ↓ trade flows => ↑
current account deficit & fiscal deficit & ↓
GDP
Tighter global funding conditions
=> spillover effects => ↓
money supply
Sovereign spreads
back to pre-crisis levels after peaking around end-08
Conditions in equity markets
improving, but still a long way to go
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Policy challenges within Africa
No single recipe -
circumstances differ so much across countries
Priority
for all countries : protect the hard-won improvements in
economic fundamentals
-
more sustainable debt levels, lower inflation, liberalized trade and structural reforms & ST preventive measures to minimize contagion
ST priorities should not detract govts
from the need for LT reforms to
build & diversify financial systems
Fiscal stimulus
MUST be used judiciously for countries enjoying
macroeconomic stability & sustainable debt levels
Countries with deteriorated terms of trade: depreciate real exchange rates to preserve macroeconomic stability
while keeping fiscal and
monetary policies sufficiently tight to avoid a devaluation-inflation spiral
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Policy challenges within Africa (cont)
Early risk detection measures (stress-testing of banks)
Closely monitor the balance sheets of financial institutions
and be
prepared to act promptly if necessary
Strengthen banking sector regulation, recapitalization of banks