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The monetary policy instruments of the Magyar Nemzeti Bank MNB, Financial analysis May 2012.

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Presentation on theme: "The monetary policy instruments of the Magyar Nemzeti Bank MNB, Financial analysis May 2012."— Presentation transcript:

1 The monetary policy instruments of the Magyar Nemzeti Bank MNB, Financial analysis May 2012

2 1.The place of the instruments within the inflation targeting regime 2.The structure of the instruments 3.Determinants of interbank liquidity on the aggregate level 4.Shocks to the liquidity of the banking system and their management 2 Topics

3 The primary objective of the MNB shall be to achieve and maintain price stability. 3 The goals of monetary policy Final target • achievement of price stability: inflation around 3% • inflation target continuously since 2007: 3%+/-1% Intermediate target • inflation forecast to be close to the inflation target • latest forecast: 5.6% for 2012; 3% for 2013 Direct, operational target: • short term market interest rates to be consistent with the central bank base rate and with the expectations of it • short term: 3-6 months

4 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. The system of monetary policy instruments of the MNB 4 Main policy instrument: 2-week MNB-bill Operational target: Short term interest rate = expected base rate Intermediate target: Inflation forecast = = medium term inflation target Final target: Price stability

5 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. Decision making mechanism of the MNB 5 Inflation and real economy forecast Monetary Council (MC): Decision on the level of interest rate Monetary instruments Short term interest rates adjust to the base rate Information Effects of the transmission channels originating from the change in the interest rate Money market analysis Financial stability analysis

6 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. Transmission channels: how the monetary policy decisions affect output and inflation 6 Source: Monetary policy in Hungary (2012)

7 1.The place of the instruments within the inflation targeting regime 2.The structure of the instruments 3.Determinants of interbank liquidity on the aggregate level 4.Shocks to the liquidity of the banking system and their management 7 Topics

8 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. The goal and basic principles of the monetary policy instruments • On the basis of the real economy and inflation forecast, on the money market situation and on financial stability issues decision makers decide on which level of interest rate they think the inflation target achievable. • The task of the instruments is to ‘adjust’ the money market yields to the level of the base rate ―To reflect the actual level and the expectations on changes in the rate. ―Not to depend on the liquidity situation, on interbank market processes. • The basic principles of the instruments ―Market conform structure (indirect tools) ―Transparent, secure and cost efficient structure ―Equal treatment of market counterparties ―Support of market building 8

9 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. What are the instruments and who are the counterparties of the MNB? • Monetary policy instruments: all the forint and FX market operations of the central bank • Counterparties: credit institutions subject to reserve requirements who accomplish certain technical conditions ―Membership in the Hungarian real-time gross settlement system (VIBER) or in the Interbank Clearing System (BKR) ―Securities account with the central securities depository and security settlement system (KELER Zrt.) • Different scope of counterparties possible according to the aims of the various instruments (e.g. in case of instruments aimed at quick intervention) ―In case of certain FX market instruments non-residents included ―In case of quick tenders only banks 9

10 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. The forint market instruments • The design of it is determined by the fact that the liquidity of domestic banks is permanently higher than what is needed to fulfil reserve requirements • The cause of the permanent liquidity surplus: ―former intervention at the strong edge of the crawling pegged exchange rate mechanism ―FX inflow of privatisations and of FX debt securities issuances of the Sovereign Debt Management Centre (ÁKK) exchanged to forint at the MNB ―conversion of EU funds at the MNB • The banking system holds the permanent surplus liquidity in the form of MNB-bills • The MNB passively drains out, sterilizes the surplus liquidity • As a result, the main policy instrument of the MNB is on the deposit side (and not on the lending side as e.g. at the ECB) 10

11 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. The standard forint market instruments OBJECTIVEINSTRUMENTFORMEFFECT Monetary policy management Base rateTwo-week bill Influence of short term yields Smoothing the volatility of interbank interest rates Interest rate corridor Overnight deposit Limiting fluctuations of interest rates Overnight collateralized loan Reserve requirements Averaging mechanism Reduces the volatility of interest rates Quick tender Deposit or collateralized loan Management of unexpected liquidity shocks 11

12 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. The main instrument of the central bank • Two-week bill • Credit institutions can buy it without upper limit on a weekly basis • The MC determines the interest rate of it (key policy rate, base rate) • Its aim: management of the money market interest rates in a way considered optimal by the central bank • Directly affects short term interest rates (operatioiinal target) • Change in the base rate has a signalling effect, it influences the expectations of market participants 12

13 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. Interest rate corridor • Corridor between the interest rates of the central bank overnight (O/N) lending and deposit facilities • Standing facilities at interest rates less favourable than the key policy rate (currently at +/-1%) • Aim: moderate the volatility of money market interest rates, small differences from the key policy rate • In case of temporary liquidity need: overnight loan opportunity against security collateral; in case of temporary liquidity surplus: deposit opportunity • In the interbank market overnight rates fluctuate between the two edges of the interest rate corridor • Cautious liquidity management in banks since the crisis, which results in accumulation of O/N deposits and in interbank interest rates close to the lower bound of the interest rate corridor 13

14 Overnight market interest rates within the central bank interest rate corridor 14

15 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. The role of the reserve requirement system • Banks must deposit a part (2-5% of less than 2-year maturity liabilities subject to reserve requirement) of their liabilities with the central bank • Its aim: reduction of the volatility of money market interest rates • Averaging mechanism: monthly average of end-of-day reserve account balances should equal the reserve requirements ―In case of temporary liquidity deficit reserve account balances can be lower, in case of temporary liquidity surplus they can be higher • No implicit taxation already, reserves are remunerated at market interest rates • Since the crisis front-loaded reserve holding 15

16 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. Other and unconventional central bank instruments • Tenders, open market operations ―Longer term loan tenders (2-week, 6-month, 2-year) ―FX-swap instruments (overnight, 3-month, until 2010 also 6- month) ―Mortgage bond program (2010) ―Government bond sell and purchase on the secondary market, rarely used instrument (e.g. during the government bond market turbulence of Autumn 2008) • Quick tender ―In case of temporary liquidity problem of the banking system, rarely used instrument (e.g. Autumn 2001) 16

17 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. Acceptable collaterals • Central bank credit can be granted only against collateral • Acceptable securities: government bonds, mortgage bonds, appropriately rated bonds (of banks, of corporates), municipal bonds • Collateral management in practice ―Lombard loan and not classical repo ―Pooling (one security portfolio serves for all central bank loans) ―Haircut dependent on the type and maturity of collateral ―Daily revaluation, in case of need additional collateral placement 17

18 1.The place of the instruments within the inflation targeting regime 2.The structure of the instruments 3.Determinants of interbank liquidity on the aggregate level 4.Shocks to the liquidity of the banking system and their management 18 Topics

19 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. 19 The MNB is the bank of banks, thus changes in the liquidity position of the banking system are tracked in the MNB’s balance sheet Change of the monthly average statistical balance sheet of the MNB, January 2008-January 2012, HUF billion

20 Cumulated change in the main balance sheet items of the MNB since January 2008 (monthly averages) 20 In the last 3,5 years along with the increase in FX reserves the liquidity surplus of the banking system has increased (the amount of two-week bills has climbed)

21 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. Changes in the liquidity surplus of the banking system on the long run go along with changes in MNB-bills The amount of MNB-bills increase when •some asset side item of the central bank balance sheet increases: –Amount of loans granted to banks increase –FX reserves (the central bank buys foreign exchange on the market) –Securities portfolio increases (the central bank buys government bond, mortgage bond on the market) •or some liability side item of the central bank balance sheet decreases: –Government account balance decreases (e.g. pension payments) => the current account balance of the banking system increases, resulting in the increase in two-week bills –Current account balance of banks decreases (e.g. reduction in the required reserve ratio) => excess reserves are tied down in two-week bills 21

22 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. •Government account ↓ • MNB-bill ↑ •FX reserves ↑ •Government account ↑ •Treasury account ↑ • MNB-bill ↓ Balance sheet of the MNB The government finances itself in forint: 22 The government finances itself in foreign exchange: FX borrowing Redemption of government bond Positive net forint government bond issuance At the end of the day MNB-bills of banks decrease. Total assets of the balance sheet does not change, only the structure of liabilities changes. At the end of the day total assets of the MNB increase, FX reserves and two-week bills also increase. The amount of MNB-bills has increased since 2008 due to FX borrowing instead of issuing forint government bonds Balance sheet of the MNB

23 1.The place of the instruments within the inflation targeting regime 2.The structure of the instruments 3.Determinants of interbank liquidity on the aggregate level 4.Shocks to the liquidity of the banking system and their management 23 Topics

24 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. Liquidity shocks of the banking system •There is fundamental difference between liquidity shocks of individual banks and of the banking system as a whole: •On the individual level risk takes the form of unpredictable customer transactions (inflows and outflows as well) •Individual liquidity shocks are manageable in the interbank money market in general •Shocks to the banking system as a whole reach all individual banks at the same time (though to different extent). •Autonomous liquidity factors: transactions of treasury account, currency in circulation, •Transactions of the MNB: FX transactions, interest payment •Central bank instruments support the management of system wide liquidity shocks (reserve requirements, interest rate corridor, intraday and longer term loans) 24

25 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. A source of liquidity shocks to the banking system is the variability of the treasury account •Government purchases increase, incomes decrease the liquidity surplus of the banking system: •The majority of government expenditures (e.g. salary payments of the public sector, pension payments) arrive to current accounts held at banks, thus increase the liquidity of banks through payment systems (the structure of the liability side of the balance sheet of the MNB changes) •In case of tax income (the largest item is the value added tax) companies transfer money from their bank accounts to the treasury account, while reducing the liquidity of the banking system. •Debt financing items have a similar effect to the liquidity of the banking system: interest payments and redemptions are government expenditures to bank customers, thus increase the liquidity, while issuance of government bonds decreases the liquidity of banks. 25

26 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. The volatility of treasury accounts is the most important autonomous liquidity factor •The daily movements of the treasury account are hardly predictable and have a significant liquidity effect (200 HUF bn a day in some cases). •The smoothing of the treasury account supports the reduction of the volatility of money market yields: •When the free liquidity of the banking system increases and the treasury account balance decreases due to government expenditures (e.g. pension payments), borrowing of the ÁKK (reverse repo) elevates the balance of the treasury account and decreases the liquidity surplus of the banking system at the same time. •When government income (e.g. VAT) increases the treasury account balance and the liquidity surplus of banks decreases, equilibrium is achieved by money market lending (repo) of the ÁKK. 26

27 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. The other source of shocks to the aggregate liquidity of the banking system is the change in demand for currency •Changes in the demand for currency cause smaller liquidity shocks (daily 10-20 HUF bn maximum) and are better predictable. •The demand for currency of the economy is driven on the one hand by seasonal factors: •Weekly seasonality: demand for currency decreasing in the first half of the week and increasing in the second half •Yearly seasonal patterns: hike in the demand for currency holding before end-of-the-year and midyear holidays, while decrease after holidays •On the other hand economic growth and inflation also affects the demand for money. •As a non-interest bearing instrument the opportunity cost of holding currency changes with inflation. The decrease (increase) in inflation usually has been followed by the increase (decrease) in the growth rate of currency holding of the public. 27

28 28 Year-on-year growth rate of currency holding of the public and the inflation

29 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. Opportunities of interbank liquidity management Weekly average expected liquidity surplus ―Banks can manage optimally their liquidity surplus by quotation of MNB-bills (available once a week) ―The MNB publishes a liquidity forecast every week, just before the auction of the MNB-bills Management of the effects of intraweek liquidity shocks ―Change of current account balance (averaging mechanism of the reserve requirement system) ―Interbank (O/N) lending or borrowing ―Recourse to the interest rate corridor of the MNB (O/N deposit or loan) 29

30 A jegybank elsődleges célja az árstabilitás elérése és fenntartása. 30 Literature •Monetary policy in Hungary (2006, 2012)Monetary policy in Hungary (2006, 2012) •Detailed monetary policy instruments (2009)Detailed monetary policy instruments (2009) •Komáromi, András: The effect of the monetary base on money supply – Does the quantity of central bank money carry any information? MNB Bulletin (June 2007)Komáromi, András: The effect of the monetary base on money supply – Does the quantity of central bank money carry any information? MNB Bulletin (June 2007) •Balogh, Csaba: The role of MNB bills in domestic financial markets. What is the connection between the large volume of MNB bills, bank lending and demand in the government securities markets? MNB Bulletin (October 2009)Balogh, Csaba: The role of MNB bills in domestic financial markets. What is the connection between the large volume of MNB bills, bank lending and demand in the government securities markets? MNB Bulletin (October 2009) •Varga, Lóránt: Introducing optional reserve ratios in Hungary MNB Bulletin (October 2010)Varga, Lóránt: Introducing optional reserve ratios in Hungary MNB Bulletin (October 2010) •Molnár, Zoltán: About the interbank HUF liquidity - what does the MNB’s new liquidity forecast show? MNB Bulletin (December 2010)Molnár, Zoltán: About the interbank HUF liquidity - what does the MNB’s new liquidity forecast show? MNB Bulletin (December 2010)


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