31 st October – 2 nd November Workshop on Developing Government Bond Market 31 OCTOBER – 2 NOVEMBER 2007, Bali, Indonesia Lessons in Monetary Policy Implementation & The Conduct of Monetary Operations Using Government Bonds Dato’ Ooi Sang Kuang Bank Negara Malaysia

31 st October – 2 nd November Outline Background Lessons in Monetary Policy Implementation Using Government Bond for Monetary Operations  Initial Roadblocks  Development Initiatives  The effectiveness of repo operations Recap of key points

31 st October – 2 nd November  Monetary policy aims at achieving sustainable growth in an environment of price stability  Monetary Policy Meeting is held 8 times a year and the statement is issued on the same day  The policy rate is Overnight Policy Rate, currently at 3.5%  Objective of monetary operations:  meet the overnight operating target;  reinforce monetary policy intention, and  manage liquidity in the interbank market.  Monetary operation focuses on managing liquidity in an excess liquidity environment Background

31 st October – 2 nd November Overnight policy rate framework is guided within a corridor Liquidity is managed over the longer horizon using longer-term repo and money market tenders to ensure rates are not persistently too low or too high Time Ceiling rate (+25 bps) Floor rate (-25 bps) Overnight rate Policy rate (3.50%) 50 bps corridor on the overnight tenor Overnight rates to gravitate around policy rate Lending facility Deposit facility  Overnight rate as the policy rate and also the operating target  Operating band of 50 basis points to minimise extreme volatility  Standing facility available at the ceiling and floor rate  Overnight rate was chosen as the policy rate high controllability minimal expectation content  Market determined rates at other tenors. Background

31 st October – 2 nd November Range of monetary instruments to sterilise liquidity has been diversified… 2001 vs 2007 Source: Bank Negara Malaysia Total liquidity: RM46.2 billion Total liquidity: RM284 billion Background

31 st October – 2 nd November Initial challenges to monetary policy implementation..  High dependence on uncollateralised interbank borrowing and lending through money market auction.  Large and volatile capital flows since 2000 into financial market – 2000 to 2004 net capital flows amounted to approximately 3.8% of GDP annually.  Growth of Islamic finance – 2000 to 2006 total asset of Islamic financial institutions as to compared to the banking system assets has increased from 2% - 7%.  Growth of domestic debt securities market –in Dec 2006 total market size amounted to USD billion or 94.8% of GDP.  Greater demand for transparency in monetary policy implementation process and operations ie: updates on market liquidity. Background

31 st October – 2 nd November Outline Background Lessons in Monetary Policy Implementation Using Government Bond for Monetary Operations  Initial Roadblocks  Development Initiatives  The effectiveness of repo operations Recap of key points

31 st October – 2 nd November Amendments in Central Bank Act was undertaken proactively to overcome impediments to operations… Effective dateDetails of amendmentInitial Impediment January 2004 Changes to allow Islamic money market operations that comply to the Syariah law for the purpose of safeguarding monetary stability. Section 42 of Central Bank Act The conduct of Islamic money market operations was initially not expressly covered by the Act. October 2006 Changes to allow substantially larger issuance of Bank Negara Monetary Notes, limited up to 100% of the size of international reserves. Section 30 (bb)(i) of Central Bank Act The limit was previously up to 3 times the total of Bank’s paid up capital and General Reserves Fund (equivalent to retained profits) Lessons learned in conducting monetary operations

31 st October – 2 nd November The framework change in April 2004 & new monetary instruments have enhanced operational effectiveness… interbank rates track OPR closely & affects bank’s average lending rates directly… Source: Bank Negara Malaysia Lessons learned in conducting monetary operations ALR vsPrior to 26 April 04After 26 April 04 Overnight interbank rate months intervention rate 0.03No longer targeted Correlation analysis on Average Lending Rate (ALR) and interbank rates

31 st October – 2 nd November Rapid development of global Islamic financial market leads to the introduction of new instruments… New InnovationDateDetails Sukuk BNM Ijarah (SBNMI) Feb Sukuk issuance based on the Al- Ijarah or ‘sale and lease back’ concept. Islamic BN Monetary Notes (BNMN-i) Dec Issued by Bank Negara Malaysia to replace the Bank Negara Negotiable Notes (BNNN) for purposes of managing liquidity in the Islamic financial market. Commodity Murabahah Programme (CMP) Feb CMP is a cash deposit product that utilises the Crude Palm Oil based contracts as the underlying assets. BNMN- Murabahah Mar BNMN-Murabahah is essentially a trustee-receipt which utilises Crude Palm Oil (CPO) based contracts as the underlying assets. Source: Bank Negara Malaysia Lessons learned in conducting monetary operations More information on these instruments can be obtained online at BNM’s Islamic Money Market website at

31 st October – 2 nd November Outline Background Lessons in Monetary Policy Implementation Using Government Bond as Monetary Operations  Initial Roadblocks  Development Initiatives  The effectiveness of repo operations Recap of key points

31 st October – 2 nd November Initial roadblocks to the use of government securities for monetary operations…. Small BNM holdings of government securities initially impede wider use…  In December 2004, BNM began to purchase MGS from primary and secondary markets based on market prices.  The purchase of MGS at primary tenders will be based on the weighted average price of the tender and limited to a maximum of 10% of the issue size.  BNM also may purchase MGS from the secondary market, however subject to maximum limit of holding MGS to 10% of the total outstanding. Source: Bank Negara Malaysia

31 st October – 2 nd November Captive market of government bonds… 64% of total MGS were hold by “buy-and-hold investors” Initial roadblocks to the use of government securities for monetary operations….

31 st October – 2 nd November Outline Lessons in Monetary Policy Implementation Using Government Bond as Monetary Operations  Initial Roadblocks  Development Initiatives  The effectiveness of repo operations Recap of key points

31 st October – 2 nd November Introduction of ISCAP to enable borrowing and lending of securities…  Institutional Securities Custodian Programme (ISCAP) was introduced in October 2004 to facilitate lending of debt securities by buy-and-hold investors  BNM act as a catalyst to free the captive holdings of MGS by institutional investors to market participants through its repo operations  Greater use of repo for sterilisation of surplus liquidity is facilitated through collateral availability from ISCAP  Regulated short-selling in MGS introduced in October 2005 as ISCAP facilitates sufficient availability of MGS to market participants for short-covering via securities borrowing and lending Institutional Lenders / FIs Lend securities Funds Collateral via repo Interbank Institutions Securities lending fees Guarantee Development initiatives More information on the ISCAP and Regulated Short-Selling of MGS may be obtained online at BNM’s Bond Infohub website at

31 st October – 2 nd November Outline Lessons in Monetary Policy Implementation Using Government Bond as Monetary Operations  Initial Roadblocks  Development Initiatives  The effectiveness of repo operations Recap of key points

31 st October – 2 nd November Sterilisation of excess liquidity via repo … more effective, and enhances repo and debt market development Effectiveness of repo operations

31 st October – 2 nd November Repo operations facilitate the smoothening of the yield curve… more bond trades at larger number of points along the government securities yield curve… Effectiveness of repo operations Market snapshot of MGS trades from 16 Feb to 29 Feb 2000 Market snapshot of MGS trades from 16 Feb to 28 Feb 2007

31 st October – 2 nd November BNM as a catalyst to encourage market to actively use repo as alternative funding instruments…  On average, cash driven repo volume are triple the size of securities driven repo mainly due to current surplus liquidity in the market  Cash-driven repo are conducted mainly for managing liquidity  Securities-driven repo supply the market with current benchmarks MGS to market participants mainly for securities lending and regulated short-selling activities. Effectiveness of repo operations Source: Bank Negara Malaysia

31 st October – 2 nd November Sterilisation costs is lower via repo…. Source: Bank Negara Malaysia  On average cost savings for cash driven and securities driven repo are around 3 bps to 50 bps respectively.  Main reasons for relatively lower borrowing rate via repo are :- Lower risk due to collateral Demand for specific securities ie: recently issued benchmark securities for secondary trading The ability for repo buyers to short sell the MGS during the repo period for fund raising Note: Spread = 1-month interbank money market rate – 1-month repo rate Effectiveness of repo operations

31 st October – 2 nd November Outline Lessons in Monetary Policy Implementation Using Government Bond as Monetary Operations  Initial Roadblocks  Development Initiatives  The effectiveness of repo operations Recap of key points

31 st October – 2 nd November Recap of key points  Earlier impediments to effective sterilisation operations may be overcome through proactive legislative changes of central bank law  New monetary instruments were necessary due to the transformative changes in the domestic financial system especially growth of the debt securities market and international capital inflows  Development initiatives such as increasing the purchase of MGS for BNM own holdings and the introduction of ISCAP helped to increase the use of government bond for monetary operations.  Increased repo operations and the issuance of BNMNs have enhanced the monetary policy implementation process by :- widening the impact of monetary policy actions to the repo and short-term debt securities market, in addition to the money market originally reduces monetary policy costs relative to direct borrowings without affecting the signalling role of the Overnight Policy Rate (OPR) target developed the market in repo & short-term debt securities