monetary policy and monetary policy instruments
DESCRIPTION
Direct and indirect instruments of monetary policyReserve requirementsStanding facilitiesOpen Market OperationsLiquidity supply & bank balance sheetFinancial crisis - different stagesUnconventional Monetary PoliciesImplications for Emerging marketsTRANSCRIPT
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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
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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
- Reserve requirements - Demand for reserves (required (RR), settlement & voluntary reserves) - Features (RR ratios, eligible assets, maintenance periods, lagged accounting) - Remuneration v/s non-remuneration - Reserves averaging (description & use) - Functions & main problems
- Conclusion to Part I
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Main roles of the Central Bank in the financial system
Evaluate channels of monetary policy
Plan scenarios, set
the policy rate and communicate
with other market players
Monopoly supplier of local currency
Control
liquidity & credit conditions (by using RRs, SFs
& OMO)
Carry out FX intervention
to control relative value of local currency
Lender of last resort
to the banking sector
Fiscal agent
of the central government in the primary securities market
Supervises banks (thru legal frameworks, regulatory ratios & sanctions)
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Monetary policy framework and implementation
Instruments Goal(s)Operating target(s)
Intermediate target(s)
Direct instruments
Indirect instruments:
Lending/deposit facilities
Reserve requirements
Disc. Mon. op.
Financial stability
Inflation stability
Growth
Full employment
Competitiveness
etc
Base money
Market interest rates
Exchange rate
etc
Money supply
Inflation rate
Exchange rate
Etc
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Monetary policy framework and implementation (cont.)
To achieve its monetary policy goals (price stability, exchange rate stability, growth, full employment, financial stability), the CB:
-sets its policy rate and
-uses instruments that it can directly control to
indirectly influence its operating targets (exchange rate, monetary base, market interest rates).
-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
and narrowest measure of
money supply)
Aimed at the balance sheet of the central bank
They are:•
reserve requirements
•
Standing facilities•
discretionary monetary operations (OMOs, OMO-type operations)
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Greater flexibility
and larger choice of targets
than direct instruments
Encourage development and deepening of formal interbank
markets
=> ↓
disintermediation
=> Financial innovation & technological developments => ↓
information & transaction costs
Allow small, frequent changes in instruments
& hence quick responses
to shocks
& possibility to quickly correct errors
Reliance on market forces => reinforce CB independence & credibility
Improvement in investment
and ↑
financial savings
Indirect instruments & a well-functioning interbank
market mutually
reinforce
each other
Advantages of indirect instruments
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Transition to indirect instruments: the conditions
Stable macroeconomic environment, reduction of barriers to entry & elimination of regulations restricting competition
Sound and competitive financial system•
Otherwise, segmentation and heterogeneity => systemic crisis
•
Well functioning interbank
market & healthy banks assets => rapid transmission of ∆
instruments to the banking system
Modernized clearing & payment systems
(to avoid volatility in reserves supply)
Adequate supervisory and legal frameworks•
To foster prudent behaviour
Requirements WITH proper enforcement on information disclosure
CB autonomy (vital for its credibility) & sound fiscal policies•
Government should refrain from pressuring CB to keep interest rates low to minimize fiscal costs
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Transition to indirect instruments: the phases
Phase 1•
a. Absorb any liquidity overhang
(by using reserve requirements (RR))
•
b. CB to help individual banks
(to meet interbank
settlement obligations)•
c. Creation of a credit facility
to inject desired amounts of funds
Phase 2•
Characterised
by reduction of reliance on RR
for sterilisation
•
Introduction of primary market issuance (eg, OMO-type operations)•
Foundation stone for development of securities secondary market
•
Adequate collateral important as: •
CB has to protect itself from incurring losses on its credit operations
•
Without collateral, CB counterparties cannot obtain liquidity•
Combination with freer interest rates
to facilitate money market development
Phase 3•
Secondary market operations
(OMO), use of standing facilities & further
refinements…
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Demand for Reserves (notes & reserve requirements)Stylised
CB balance sheet
Reserve demand = Currency + {required + voluntary + free (or settlement) reserves}
Excess reserves = Settlement + voluntary reserves
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 ↓
impact of changes in RR
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Settlement (free) reserves: NON-binding reserve req
Exist as interbank
payments
usually settled via accounts at CB
Better CB technical capacity
& payment & settlement systems => ↓
free
reserves
Liquidity mgt problems
& high overdraft penalties
=> ↑
free reserves
If not remunerated
(opportunity cost) => banks keep minimum free reserves
Remunerated free reserves
(usually at deposit SF rate, normally < policy rate)
=> ↓
opportunity cost => free reserves ↑
↑
free reserves => liquidity surplus
=> trigger CB to↑
policy rate
Free reserves usually high
when CB’s balance sheet
asset-driven
(eg, when
govt
borrows abroad and sells FX to CB; when CB makes net purchases of FX to manage a fixed exchange rate regime and capital flows)
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Features of reserve requirements
RR with Uniform or differentiated ratios•
Applicable to domestic and foreign currency
(FC) liabilities with different
maturities•
Differentiation –
to attract or to discourage FC deposit inflows
(v/s
LC
deposits) or ST v/s
LT
deposits•
Countries (among which many African) using differentiated ratios
have in
general higher RR ratios
=> ↑
risks of disintermediation•
Uniform ratios (CB neutral with respect to currency / maturity of deposits)
•
Equitable, easier to calculate RR & to monitor•
Avoid shifts in deposits, ST capital flows & exchange rate pressures
Eligible assets?•
Include: usually, deposits with CB (demand, time, FC), vault cash (debatable –
estimation problems)
•
Exclude: government securities & OMO eligible instruments
=>to avoid ↓ efficiency of monetary policy thru increased complexity
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Implications of using FC deposits as eligible assets for RR
RR on FC deposits: •
Reflects balance sheet structure of banks, hence of customer preferences
and even distrust in local currency
•
↓
the bias on LC deposits & exposure to capital flows•
If exchange rate unstable
=> reserves demand unstable & unpredictable
FC deposits
(% of total deposits) very big
in many EMEs
(esp. Africa)
•
Common practice: RR on FX deposits in the LC, while corresponding liabilities are in FC => ↑
exposition to currency risk
LC depreciation
=> Banks have to ↑
reserve balances at CB => demand for
liquidity ↑
as banks forced to sell FC for LC or borrow liquidity from CB (at high penalty rates) => CB has to carry out policy expansion
(for eg, by ↓
policy rate) to counter liquidity shortage problems•
↓
policy rate
may => more depreciation
(vicious circle!)
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Features of reserve requirements (cont.)
Maintenance period (MP) –
period over which banks’
average holdings of
reserves
are assessed relative to requirements (US: 2 weeks, JP: 1 month; ECB: 28-35 days)•
Function of CB’s passivity/activity
in intervention to monitor liquidity
•
Long MP => ease
requirement conditions
=> ↓
excess reserves•
For determination of end-dates
of MP:
•
avoid days of high liquidity uncertainty
(eg, tax payment dates)•
avoid speculation & volatility: alignment with policy decision
announcement dates
Lagged reserve accounting•
Calculation of RR for next MP can be done before end-date of MP
=>
helps banks plan reserve holding pattern in advance & build-up confidence
Carrying over excess reserve holdings
into next MP
=> more smoothing,
esp. last day of MP (when O/N rate volatility is higher)
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No Remuneration or RR remunerated below policy rate
Income source for the CB
= tax on the financial system => disintermediation
Less income for banks
=> banks
may ↑
spreads between deposit & lending rates
to clients to compensate for loss
Remuneration rate
= usually the policy rate for RR
and deposit SF rate for excess RR
High remuneration
=> ↑
excess (voluntary) reserves
No remuneration
but high RR
=> ↑
comparative disadvantage of banks
relative to non-banks (who are not subject to RR)
No remuneration, high inflation & lower interest rate differential with other countries
=> ↑
real opportunity cost (ie, implicit tax burden) on FX deposits =>
disintermediation & capital flight
•
↑
domestic interest rates
=> ↓
interest rate differential => partial compensation (deposits earn higher returns), but ↑
opportunity cost of “non
remunerated”
deposits subject to RR v/s
deposits not subject to RR
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Reserves averaging (cushion effect)
Banks can postpone reserves accumulation
to a later date of the MP, except
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?
Liquidity-draining is costly
to CB => ↓
CB profitability & independence
CB carry out liquidity-draining by ↑
policy rate => -ve
effect on credit growth
Interference with transmission mechanism
of monetary policy => liquidity forecasting & monetary policy implementation complicated & imprecise
Market segmentation
–
big banks attract all deposits
while small banks are short of liquidity
Collusion
between big banks to ↑
pressure on small banks => ↑
risks of losses for CB => ↓
CB independence
EMES: weak market infrastructure, lack of competition & insufficient voluntary participation
=> CB unable to carry out efficient liquidity-draining
Issuance of same securities by both CB & govt
(to drain liquidity) => confusion & competition
bet. them => ↓
CB independence
in case of losses
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Main sources of surplus liquidity
Net FX reserves•
Commodity exports
•
Foreign borrowing by govt
(who sells FX to CB to obtain local currency)•
FDI (FX receipts sold to CB for local currency)
•
Donor Funds
(esp. in Africa: Ethiopia, Ghana, Malawi, Mozambique, Uganda, etc)
•
Remittances (esp. countries with large emigrated citizens)
Main source in fixed or managed exchange rate regimes, as:•
FX stability perceived as key anchor for low inflation expectations
•
Export-competitiveness
important
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Main sources of surplus liquidity (cont)
Monetary financing (= lending to government)•
May be detrimental to CB independence
=> coordination is needed
•
Better be in the form of marketable securities
as then CB can sell them in the market to drain liquidity
Reduction in reserve requirements•
Crude measure of liquidity management (costly & disintermediation)
Bank rescue (LOLR) – the case with the recent financial crisis ?•
Crisis
=> ↑
demand for liquidity as:
•
Banks want to ↑
precautionary reserves•
Banks are
reluctant to lend to each other
•
If CB bails out
a bank =>↑
CB assets
=> surplus liquidity•
If CB makes losses => may endanger
CB’s independence
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Standing facilities (SF)
Usually come
after
use of discretionary monetary operations, in liquidity mgt plans
At initiative of the banking system
=> CB does not enjoy full control
SFs
are bilateral
(v/s
most OMOs
are multilateral)
INDIRECT form of liquidity
management (OMOs: direct approach)
When SF rates
low => SFs
used as permanent LOLR facility (ie, => over-reliance)•
Over-reliance =>
moral hazard =>
danger to development of
interbank
markets (CB’s SFs
acts as rough substitute to interbank
markets)•
Need for penalty rate
& regulation
•
However, Penalty rate may lead indirect stigma & discourage use when appropriate (eg, the US at beginning of current financial crisis)
Functions & Use•
Enhance CB credibility
(bears a pre-specified interest rate –
a commitment)
•
Safety valve
or
back-stop: ↓
volatility of ST int
rates around
the policy rate•
Rate-setting
or rate-stabilising: keep ST interest rate close
to policy rate
•
Used more often
when other indirect instruments not very effective
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Credit Standing Facilities (SFc; also called Lending facility)
Form of liquidity injection
Help meet reserve deficiencies
& avoid end-of-day overdrafts
=> limit pressures on overnight rates
SFc > Market rates => market-ceiling
rate for market rates•
if market rates threaten to rise above SFc, banks tend to borrow more from SFc
than from the market=> limit rise in market rates
High SFc
= signal of tightening monetary policy
Often used as the penalty rate on unfulfilled RR
commitments at end of MP
Use of SFc
↑:•
When current accounts are not monitored properly
=> banks don’t meet
their RR, esp
on last day of MP due to liquidity forecasting errors•
With credit rationing, market segmentation, liquidity hoarding (during crises); ECB (1st
week Oct 08: daily avg
use of SFc
went from 0.5 bil euros to 21 bil
euros)
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Deposit Standing Facilities (SFd)
Form of liquidity absoption
Facility for banks to deposit remunerated
funds at CB
SFd
< market rates
=> floor-setting
for market rates
SFd
> O/N interest
rate = signal of illiquid interbank
market
(less dev. countries)
Less widely used than SFc
(esp
in developed countries –
more often characterised
by liquidity shortages)
When market-wide liquidity surplus
=> SFd
≈
policy rate
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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43
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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44
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
Singapore Collaterised
credit Deposit O/N cash rate + 50 bp O/N cash rate -
50 bp
Taiwan Fixed rate loan Discount rate + 37.5 bp
UK Repo Deposit Policy rate + 25 bp
(since Oct 2008)
Policy rate -
25 bp
(since Oct 2008)
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45
Discretionary monetary operations
Done at the initiative of CB with
Voluntary participation
of the banking
system
Most flexible & widely-used
tool by CB for liquidity management
Can be used
regularly or irregularly
and
in any quantity
Influence interbank
rates to ↓
volatility
of ST rates, or to steer interbank
rates
towards levels considered appropriate with the desired stance of monetary policy
& consistent with macroeconomic policies.
Require a certain number of conditions to be effective
Come with large choice
of instrument-types, maturities, frequency of use
Available thru various auction/tender formats
Used in both primary markets
(first-time instrument issue) and secondary
markets
(trading of already issued instruments)
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46
Conduct of discretionary monetary operations
2 ways:•
Can be actively aimed at a given quantity of reserves, letting the price of reserves fluctuate
freely along with fluctuations in the
pressure on banks’
liquidity.
•
Can be aimed at a particular market interest rate, letting the amount of reserves
provided at the central bank’s own initiative to be
determined passively as a function of demand at that price.
Well functioning interbank
market
& Liberalized interest rates
•
No interbank
market = NO issuance of securities & CB paper = no discretionary monetary operation
•
Interest rate controls => disintermediation
Conditions for implementation
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47
Conditions for implementation (cont.)
Sound, competitive banks
for rapid and efficient transmission mechanism
Adequate book-entry, payment and settlement systems
to build up confidence
& increase flexibility of operations
Technical capacity of central bank
–
liquidity forecasting
•
If a bank doubts quality of forecast, it will be reluctant to participate in an OMO
Effective banking supervision & CB autonomy
(capital standards, doubtful
loans provisioning, collateral requirements, enforcement, financial reporting, etc)
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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48
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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49
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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50
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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51
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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52
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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53
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
Difference with collateralised
borrowing: ownership
of the securities is not retained by the seller
Repo = liquidity injection; reverse-repo = liquidity-draining
Most flexible and common
OMO
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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54
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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55
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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56
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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57
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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58
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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59
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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60
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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61
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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63
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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64
Part III
Financial crisis development stages
Major CB operations in advanced countries
Unconventional Monetary Policies (UMP)
Effects on Emerging markets
Effects on African countries
Restricted
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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66
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 => ↑
uncertainty => ↑
concerns about counterparty & credit risk => ↑
volatility
=>
↑
Libor –
OIS spreads (measure of liquidity risk)
=> 1st CB coordinated action & introduction of USD swap lines
Mounting writedowns
& fears of downgrades
=> forced sale of assets
in thin markets => ↑
deleveraging
& insolvency
Stage 2 (3/08 – 15/09/08): insolvency concerns & Lehman failure
↑
insolvency
concerns => ↑
liquidity hoarding
& more concerns over counterparty risks => further ↑
in CDS spreads (meas. of counterparty risk)
& ↓
equity markets
Tightening collateral conditions => ↑
pressure on investment banks => failure of Lehman Brothers
(15/09/2008)
=> Turning Point
(until then, CBs were concerned
with persistently high inflation
& thus resisted cutting policy rates
(except Fed)) => sudden escalation of fears of disinflation => drastic policy rate cuts to almost 0 by May 09 in many industrialized countries
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67
Development of the crisis (Aug 07 to mid-July 2009, cont.)Stage 3 (15/09/08 – 10/08): market turmoil becomes a global crisis
Lehman failure (LF) => crisis of confidence
& ↑
mutual funds’
exposure
to LF- issued notes => forced liquidation
of assets => ↑
demand for USD interbank
funds
LF => Use of Unconventional Monetary Policies by CBs &
massive govt intervention
(guarantees, recapitalisation/nationalisation, asset purchases)
Stage 4 (10/08 – 03/09): Global economic downturn
Questions arising about scope of govt
intervention
& impact on debt holdings
=> 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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68
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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69
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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70
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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71
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)
(UMP = Unconventional Monetary Policy)
Results:•
Improvement recently (lower spreads & volatility & ↑
asset prices)
•
huge ↑
in CB’s balance sheet & ∆
in composition•
=> greater risk exposure for CB => ↑
threats to CB independence
•
=> ↑
importance of more coordination with fiscal authorities
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72
Main characteristics of CB actions during the crisis
Higher
freq of fine-tuning operations
(for more sensitive responses)
More favourable
SF lending
facilities (help cap ST interest rates)
Increased supply of LT funds
(accommodate demand for term funds)
Wider range of collateral
& set of counterparties
(improve access &
distribution of CB funds)
Increased securities lending
(underpin market liquidity)
Increased reserves cushion
(dampen fluctuations in reserves demand by
remuneration of RR & increasing tolerance range around target RR)
Increased international cooperation
(facilitate cross-border distribution of
liquidity, eg. FX swap lines)
Direct funding & purchases
(reduce systemic risks from impaired to
unimpaired markets)
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73
Achieve the official stance of monetary policy (conventional MP)
↑
instability
of reserves demand =>↑
flexibility (& volatility) in supply
of
reserves
Narrower corridorNarrower corridor
=> ↓
interest rate volatility
& ↑
use of SFs
–
safety valve
Liquidity-draining operations:
•
issuance of CB bills
(BoE, SNB)•
Accept more ST deposits & Treasury deposits
•
↑
remuneration rate on RR
to ↑
their attractiveness
In line with CB’s LOLR to banks; difference on range & magnitude
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74
Influence wholesale interbank market conditions (conventional MP)
In line with CB’s LOLR fn; diff
on wider range
& magnitude v/s
trad. levels
Main goal: ↓
interbank
market spreads to:•
Provide more term funding
& Smooth distribution of reserves
FX swap lines = facilitate FC provision; main balance sheet expansion factor
Lending highly liquid securities against less liquid
assets & doubtful collateral => ↑
credit & market risk for CB
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75
Influence credit market and broader financial conditions (UMP)
Main goal: alleviate tightening non-bank
credit conditions –
CB as LOLR Mostly at stages 3, 4 & 5
(intensification before better conditions)
Securities purchases –
quasi-fiscal element
=> need more careful coordination with debt mgt operations!!!
QE when CB cannot ↓
int
rates further as they are at 0!!! –
assets purchase => ↑ deposits at CB => ↑
excess reserves
that could be used for lending purposes
CE
focuses on mix of loans & securities
held by CB => ∆
asset composition
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76
How do UMPs feed into the real economy?
Communication:
conditional CB statements
on future path of policy
& objectives => ∆
inflation expectations
& risk premia
•
To avoid misinterpretations,
CB to give broad info also in normal times
about factors expected to influence upcoming OMOs
=>
↑
familiarisation
Quantitative easing
(QE):
↑
reserves via pre-specified
outright purchases
of government or government-guaranteed
securities
from banks
•
Kicks in when policy rates = or close to 0 –
instrument of mon. policy shifts towards the quantity of money
provided
rather than int. rate
•
Goal:
↓longer-term int. rate independently of risk & control inflation
•
Affect market for risk free assets, typically longer-term govt
bonds
•
Problem:
LT yields are already very low!!! Why lower them more?
•
Example:
Japan (03/01 to 03/06) –
flood the market with excess yen liquidity to ↑
inflation to +ve
levels, while committing to zero int. rates.
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77
How do UMPs feed into the real economy? (cont.)
Credit easing
(CE):
↑
credit flows
via purchases of private
assets
in
specific sectors/markets or direct financing to corporate borrowers•
Problems:
Credit risk & resource reallocation issues => “blurring”
of
line between fiscal & monetary policy => danger to CB independence
CE
affects risk spread across assets between well-functioning markets
and those that are impaired
Many CBs don’t distinguish QE from CE
Endogenous credit easing
(ECE):
lending to banks at longer maturities,
against collateral that includes assets whose markets are temporarily impaired via
fixed rate tender procedures with full allotment (ECB)
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78
Quantitative easing in Japan (March 01 – March 06)
19/03/01: shift of operating target
from O/N call rate to level of current acct balances
(reserves) at banks (changed 9 times until 09/03/06)
Accompanied by outright purchases of LT JP govt
securities
Results: •
↑
in BOJ’s
balance sheet
•
Lowering of term-structure of govt
securities•
↓
uncertainty about future funding & pickup in economic activity
Inflation (Y/Y % change) CAB (tr. Yen) Policy rates
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79
Risks and challenges posed by UMP
Inadvertent credit allocation to inefficient markets
=> constrain financial
sector restructuring in ST=> impair future economic growth
Replacement of high-quality liquid assets with illiquid claims
on CB
balance sheets => constrain monetary management
Quasi-fiscal nature
blurs distinction
between monetary and fiscal policies
=> potentially compromise central bank independence
Inflation potential
of ↑
reserve money
=> ↑
inflation expectations in
response to some announcements of UMP•
Ongoing and detailed communication can help to reduce the risks
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80
Effects on CB assets and repos
UMP => large ↑
in CB balance sheet (Fed’s & BoE’s
assets
almost X3, by end-08)
Reflection of aggressiveness of easing
& nature of financial system
Liquidity injection X4
for BoE & more than tenfold for Fed
Highly volatile use of LT repos
(from 0 to 100 %) –
reflects high freq of LT fine- tuning operations
and their irregular nature
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81
Effects on Central Bank asset composition (billions of national currency)
Fed & BOJ more active in buying govt
& private
securities
than BoE & ECB
Stigma attached to use of discount window in US
(before end-08) limited use until then. TAF => increase in use of lending facilities
ECB & BoE use lending facilities more intensively
than securities’
purchases (more temporary v/s
permanent liq
mgt)
Use of FC ↓
compared to end-08, esp
with BoE –
replaced by direct lending
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82
Effects on interest rates & OMO in the US
Policy rate almost 0
Improving signs… TAF has helped
in
easing money market conditions…
Massive liquidity injections
=> Funding
spreads
now very low at all maturities & less volatile
=> sign
of improving funding conditions
Bid-to-cover ratio ↓ => urgent need to
borrow ↓
Stop-out rate no longer > min. bid rate –
growing investor
confidence
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83
Effects on interest rates & OMO in the euro area
Fixed-rate MRO with full allotment period
Unlike US, policy rate > 0
(1% on 22/07/09)
Funding spreads very low
at all maturities, but
still high volatility
Fixed-rate MRO
with full allotment
(since
15/10/08) to restore confidence
7 May 09: plan to purchase covered bonds
=> ↓
spreads & encourage LT funding
Problem:
instead of lending, banks ↑
use of
deposit facilities…
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84
Effects of government bank-rescue packages on 5-year CDS spreads Unweighted average; in basis points
Spreads have ↓
from peaks, everywhere
Banks with govt
support not doing better
than those without support (Europe & UK)
Consistency of govt
guarantees important as lack of clarity slows banks’
efforts to secure funding & dampen investor interest
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85
Performance of major banks until late July 2009
Mixed feelings, but on the whole still in negative
Uk
and esp. US banks in very bad shape, in spite of gov
& private
support (except GS)
Asia-based banks globally in better shape
Still high CDS spreads –
threat to
investors’
viability
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86
Going forward: difficulty with assessing real impact of UMPs
New “untested”
environment (lack of experience) => calibration
problems
Assumptions based on past experience
may not be a good guide for the future
Transmission channels are impaired & unconventional: directed measures => distortions & interactions between standard & non-standard elements
Lags &
Durability of impact
–
is it going to last? How to unwind positions smoothly? When to do so?
Communication:
misunderstood decisions => negative effects on economic agents
Success depends on design & magnitude
of the measures but also on the willingness and ability
of creditors to lend & of borrowers to borrow
Density of different measures & international dimension
of certain measures (FX swaps lines) => uncertainty on which effects
attributable to which measure?
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Going forward: exit strategies
Needed to give borrowers an incentive to return to interbank
markets
•
Should include retightening of funding conditions, traditional liquidity-draining operations
& RR readjustment
Liquidity-draining options:•
Sale of securities outright; reverse repos
;↑
attractivity
of bank
reserves holdings; Issue CB bills
ST operations CAN be allowed to expire
and rising interest rates
will
act as a disincentive to continue to use the CB as counterparty
LT assets-
more difficult to offload
More important for exit:
TIMING of exit & NOT the unwinding of
balance sheet size
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Going forward: exit strategies (cont.)
Why? Because:•
Tightening “too early”
=> with low inflation, ↑
interest rates => ↓
inflation, investment & consumption •
Tightening “too late”
=> high inflation
=> large imbalances =>
another cycle of ↑
leverage & ballooning asset prices (base of current crisis)
Communication & clear explanation of policy decisions•
Very important for CB credibility
•
Bad communication
=> ambiguous reaction to news & stigma•
Clear separation of monetary & fiscal policies
to maintain
operational independence of CB
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What about emerging markets?
Pretty resilient until late 2008
(less developed financial markets, banks
with lower leverage ratios, strong domestic demand, high level of FX reserves, lags in contagion effects)
Downside risks
materialize in early 2009
↓
trade volumes (& receipts) & ↓
commodity prices
=> ↓
macroeconomic
growth
Deleveraging
(=> sale of EME subsidiaries & net capital outflows (home
bias
& higher regulatory capital charges
due to currency risks) => ↓
FDI & credit-rationing
=> ↑
refinancing problems & insolvency pressures
High external debt refinancing needs
=> EMEs
very exposed to financial
distress
Strong & coordinated policy actions needed from EME policymakers
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EME asset classes’ Heat map
Pretty resilient until late 2008
↓
consumption in earlier-hit advanced economies
=> ↓
exports, production & sales as revenues in EMEs
↓
Spillover effects
creeping in through the financial system (banks and corporates facing funding problems)
Downgrades & crowding-out effects
affecting Sovereign spreads
Growing uncertainty & loss of investor confidence
affecting equity markets as domestic conditions worsen
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Emerging market high-frequency indicators
Financial markets take full toll in Q4 08 => large depreciations
to support exports
Liquidity hoarding & fiscal stimulus sustainability uncertainty => ↑
sovereign spreads
↓
equity prices & CDS spreads ↑
as confidence drops
Bond yields ∆
a lot as uncertainty grows over authorities’
actions
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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
Large policy rate cut impact mitigated by ↓
inflation (=> real int
rates constant) + tighter funding conditions (more cautious banks & ↑
risk premiums)=> ↓
private
credit growth => need for UMP (=> ↑
CB assets)
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Policy actions
↓
policy rates, RR and SFc↓
=>
expand liquidity provisioning
OMO:
↑
repos
=> 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
Weak & unstable domestic currencies; High & volatile interest rates & inflation
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
and
pursue prudent capital flow management
Contingency plans => ↓
potential runs on banks & cross-border crisis
management
Regional cooperation: implement emergency assistance programmes
(AfDB
-
Emergency Liquidity Facility, the Trade Finance Initiative and other ways of support to low-income countries)
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Conclusion to Part III
Signs of improving situations
indicate that unprecedented monetary easing
conditions & massive govt
intervention are being successful in restoring confidence & normalizing interbank
transactions, although credit conditions
still remain largely impaired, esp, LT
Current financial crisis has shed light on importance of:
Good liquidity management by the CB, both in calm & turbulent times –
good & timely forecasting
+ ability to carry out operations with the necessary tools independently
& to communicate clearly
its intentions (esp
on UMP &
exit strategies)
Need of close coordination between monetary & fiscal policies
& the role of
govt
support
& UMP when conventional monetary policies reach their limits
CBs to understand better asset-price & credit boom formation
& associated
risks & take necessary measures to counter them in a timely & smooth manner
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Conclusion to Part III (cont)
Supervision & legal frameworks
that prevent build-up of excessive leverage
Contagion & spillover effects
of crises stemming from developed financial
markets to EMEs
Need for monetary & fiscal authorities in
EMEs
to come up with measures
to support local financial markets & corporates
–
shifts in production patterns from export-
& leverage-led growth models to more balanced &
diversified ones
Strong policy commitments that resist protectionism
& encourage an orderly
adjustment, by striking a balance bet. ST stimulus & exit strategies
that ensure LT sustainability
System-wide macroprudential
policies
able to tackle procyclicality
inherent
in the financial system
& identify all risk sources & having the means to counter/reduce them to ensure global financial stability
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Thank you….
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Supportive charts…
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Investors confidence up: global risk appetite returning…. (based on survey data on risk appetite, investment time horizon,
and cash position)
Source: Merrill Lynch.
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Indicator of liquidity conditions (eg, depth of markets, narrowness of bid-offer spreads, ease of execution, etc) = back to normal?
Source: Merrill Lynch.