Module 4 - Bangko Sentral ng Pilipinas, Monetary Policy, and Interest Rates PDF

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Warning: TT: undefined function: 32POLICY, AND INTEREST RATES Saunders and Cornett, Financial Markets and Institutions, 2019, 7th Ed, New York: McGraw Hill Education ** Madura, Financial Markets and Institutions, 2015, 11th Ed, Australia: Cengage Learning 1CENTRAL PHILIPPINE UNIVERSITYCollege of Bus...

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Module 4

BANGKO SENTRAL NG PILIPINAS, MONETARY POLICY, AND INTEREST RATES CENTRAL PHILIPPINE UNIVERSITY College of Business and Accountancy

Acctg 3115 – Financial Markets First Semester Module # 4 BANGKO SENTRAL NG PILIPINAS, MONETARY POLICY, AND INTEREST RATES

Objectives: At the end of this chapter, the students are expected to: 1. understand the function of the BSP and its structure; 2. identify the monetary policy tools used by the BSP; 3. understand how monetary policy changes affect key economic variables; and 4. understand how central banks around the world adjusted their monetary policy during financial crisis.

THE BANGKO SENTRAL NG PILIPINAS

The Bangko Sentral ng Pilipinas (BSP) is the central bank of the Republic of the Philippines. It was established on 3 July 1993 pursuant to the provisions of the 1987 Philippine Constitution and the New Central Bank Act of 1993. The BSP took over from the Central Bank of Philippines, which was established on 3 January 1949, as the country’s central monetary authority. The BSP enjoys fiscal and administrative autonomy from the National Government in the pursuit of its mandated responsibilities. The BSP Vision The BSP aims to be recognized globally as the monetary authority and primary financial system supervisor that supports a strong economy and promotes a high quality of life for all Filipinos. The BSP Mission To promote and maintain price stability, a strong financial system, and a safe and efficient payments and settlements system conducive to a sustainable and inclusive growth of the economy. The BSP Values

* Saunders and Cornett, Financial Markets and Institutions, 2019, 7th Ed, New York: McGraw Hill Education ** Madura, Financial Markets and Institutions, 2015, 11th Ed, Australia: Cengage Learning ***www.bsp.gov.ph

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BANGKO SENTRAL NG PILIPINAS, MONETARY POLICY, AND INTEREST RATES

OVERVIEW OF FUNCTIONS AND OPERATIONS Objectives The BSP’s primary objective is to maintain price stability conducive to a balanced and sustainable economic growth. The BSP also aims to promote and preserve monetary stability and the convertibility of the national currency. Responsibilities The BSP provides policy directions in the areas of money, banking and credit. It supervises operations of banks and exercises regulatory powers over non-bank financial institutions with quasi-banking functions. Under the New Central Bank Act, the BSP performs the following functions, all of which relate to its status as the Republic’s central monetary authority. •

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Liquidity Management. The BSP formulates and implements monetary policy aimed at influencing money supply consistent with its primary objective to maintain price stability. Currency issue. The BSP has the exclusive power to issue the national currency. All notes and coins issued by the BSP are fully guaranteed by the Government and are considered legal tender for all private and public debts. Lender of last resort. The BSP extends discounts, loans and advances to banking institutions for liquidity purposes. Financial Supervision. The BSP supervises banks and exercises regulatory powers over non-bank institutions performing quasi-banking functions. Management of foreign currency reserves. The BSP seeks to maintain sufficient international reserves to meet any foreseeable net demands for foreign currencies in order to preserve the international stability and convertibility of the Philippine peso. Determination of exchange rate policy. The BSP determines the exchange rate policy of the Philippines. Currently, the BSP adheres to a market-oriented foreign exchange rate policy such that the role of Bangko Sentral is principally to ensure orderly conditions in the market. Other activities. The BSP functions as the banker, financial advisor and official depository of the Government, its political subdivisions and instrumentalities and government-owned and -controlled corporations.

The BSP's Organizational Structure

* Saunders and Cornett, Financial Markets and Institutions, 2019, 7th Ed, New York: McGraw Hill Education ** Madura, Financial Markets and Institutions, 2015, 11th Ed, Australia: Cengage Learning ***www.bsp.gov.ph

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BANGKO SENTRAL NG PILIPINAS, MONETARY POLICY, AND INTEREST RATES

Governance of the Bank The Monetary Board exercises the powers and functions of the BSP, such as the conduct of monetary policy and supervision of the financial system. Its chairman is the BSP Governor, with five full-time members from the private sector and one member from the Cabinet. The Governor is the chief executive officer of the BSP and is required to direct and supervise the operations and internal administration of the BSP. A deputy governor (or a Senior Assistant Governor in the case of the Currency Management Sector) heads each of the BSP's operating sector as follows: • •

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Monetary and Economics Sector is mainly responsible for the operations/activities related to monetary policy formulation, implementation, and assessment Financial Supervision Sector is mainly responsible for the regulation of banks and other BSP-supervised financial institutions, as well as the oversight and supervision of financial technology and payment systems Currency Management Sector is mainly responsible for the forecasting, production, distribution, and retirement of Philippine currency, as well as security documents, commemorative medals, and medallions Corporate Services Sector is mainly responsible for the effective management of corporate strategy, communications, and risks, as well as the BSP's human, financial, technological, and physical resources to support the BSP's core functions

The BSP's Approach to Monetary Policy The primary objective of the BSP's monetary policy is “to promote price stability conducive to a balanced and sustainable growth of the economy” (Republic Act 7653). The adoption of inflation targeting framework of monetary policy in January 2002 is aimed at achieving this objective. Inflation targeting is focused mainly on achieving a low and stable inflation, supportive of the economy’s growth objective. This approach entails the announcement of an explicit inflation target that the BSP promises to achieve over a given time period. To achieve the inflation target, the BSP uses a suite of monetary policy instruments in implementing the desired monetary policy stance. The reverse repurchase (RRP) or borrowing rate is the primary monetary policy instrument of the BSP. Other monetary policy instruments include: • encouraging/discouraging deposits under the term deposit auction facility (TDF); • standing liquidity facilities, namely, the overnight lending facility (OLF) and the overnight deposit facility (ODF); • increasing/decreasing the reserve requirement; • adjusting the rediscount rate on loans extended to banking institutions on a short-term basis against eligible collateral of banks' borrowers; • outright sales/purchases of the BSP's holding of government securities MONETARY POLICY TOOLS Understanding the conduct of monetary policy is important because it affects not only the money supply and interest rates but also the level of economic activity and hence our wellbeing.

* Saunders and Cornett, Financial Markets and Institutions, 2019, 7th Ed, New York: McGraw Hill Education ** Madura, Financial Markets and Institutions, 2015, 11th Ed, Australia: Cengage Learning ***www.bsp.gov.ph

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1. Open Market Operations (OMO) Open market operations are particularly important because they are the primary determinant of changes in bank excess reserves in the banking system and thus directly impact the size of the money supply and/or the level of interest rates. When the BSP purchases securities, it pays for the securities by either writing a check on itself or directly transferring funds (by wire transfer) into the seller’s account. Either way, the BSP credits the reserve deposit account of the bank that sells the securities. This transaction increases the bank’s excess reserve levels. When the BSP sells securities, it either collects checks received as payment or receives wire transfers of funds from these agents (such as banks) using funds from their accounts at the BSP to purchase securities. This reduces the balance of the reserve account of a bank that purchases securities. Thus, when the BSP sells (purchases) securities in the open market, it decreases (increases) banks’ (reserve account) deposits at the BSP. Reverse Repurchase/Repurchase transactions In a repurchase transaction, the BSP buys government securities (GS) from a bank with a commitment to sell them back at a specified future date at a predetermined rate, resulting in an expansionary effect on liquidity. Conversely, in a reverse repurchase (RRP) operation, the BSP also acts as the seller of GS and the bank’s payment to the BSP has a contractionary effect on liquidity. Issuance of BSP Securities BSP Securities refer to negotiable monetary instruments issued by the BSP as part of its structural liquidity management operations. The issuance of securities by the BSP absorbs excess liquidity from the financial system by locking funds in longer-term monetary instruments. Securities issued by the BSP, which may be in the form of bills and/or bonds, can be traded in the secondary market. Outright purchases and sales of securities An outright contract involves direct purchase/sale of government securities by the BSP from/to the market for the purpose of increasing/decreasing money supply on a more permanent basis. In such a transaction, the parties do not commit to reverse the transaction in the future, creating a more permanent effect on the banking system’s level of money supply. Foreign exchange swaps Foreign exchange swaps refer to transactions involving the actual exchange of two currencies (principal amount only) on a specific date at a rate agreed on the deal date (the first leg), and a reverse exchange of the same two currencies at a date further in the future (the second leg) at a rate (different from the rate applied to the first leg) agreed on deal date. 2. Acceptance of term deposits The BSP, like other central banks, offers term deposits as one of the monetary tools to absorb liquidity. The Term Deposit Auction Facility (TDF) is a key liquidity absorption facility used by the BSP for liquidity management and used to withdraw a large part of the structural liquidity from the financial system to bring market rates closer to the BSP policy rate. 3. Standing liquidity facilities The BSP offers standing liquidity (lending and deposit) windows that help counterparties adjust their liquidity positions at the end of the day. These standing overnight facilities are available on demand to qualified counterparties during BSP business hours. The two standing facilities

* Saunders and Cornett, Financial Markets and Institutions, 2019, 7th Ed, New York: McGraw Hill Education ** Madura, Financial Markets and Institutions, 2015, 11th Ed, Australia: Cengage Learning ***www.bsp.gov.ph

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that form the upper and lower bound of the corridor are set at ± 50 basis points (bps) around the target policy rate (the overnight RRP rate under the new IRC structure). Overnight Deposit Facility The standing overnight deposit facility will absorb any residual system liquidity to prevent market interest rates from falling below the corridor. Interest rate for the O/N deposit facility is the RRP rate minus 50 bps (0.50 percentage point). The interest rate for the O/N deposit facility serves as a floor for the O/N interbank rate. Overnight Lending Facility The standing overnight lending facility provides collateralized overnight funding to BSP counterparties to clear end-of-day imbalances. Interest rate for the O/N lending facility is the RRP rate plus 50 bps (0.50 percentage point). The interest rate for the O/N lending facility serves as a ceiling for the O/N interbank rate. 4. Rediscounting The BSP extends discounts, loans and advances to banking institutions in order to influence the volume of credit in the financial system. The rediscounting facility allows a financial institution to borrow money from the BSP using promissory notes and other loan papers of its borrowers as collateral. The rediscounting facility has two categories namely, Peso Rediscount Facility and Exporters Dollar and Yen Rediscount Facility (EDYRF). The Peso Rediscount Facility interest rates are based on the latest available BSP overnight lending rate plus the applicable term premia. The EDYRF interest rates are based on the 90-day London Inter-Bank Offered Rate for the last working day of the immediately preceding month plus 200 basis points plus the applicable term premia for loan maturities exceeding 90 days. Raising the discount rate signals that the BSP would like to see a tightening of monetary conditions and higher interest rates in general (and a relatively lower amount of borrowing). Lowering the discount rate signals a desire to see more expansionary monetary conditions and lower interest rates in general. 5. Reserve requirements Reserve requirements refer to the percentage of bank deposits and deposit substitute liabilities that banks must set aside in deposits with the BSP which they cannot lend out, or where available through reserve-eligible government securities. Changes in reserve requirements have a significant effect on money supply in the banking system, making them a powerful means of liquidity management by the BSP. Reserve requirements are imposed on the peso liabilities of universal/commercial banks (UBs/KBs), thrift banks (TBs), rural banks (RBs) and cooperative banks (Coop Banks), and non-bank financial institutions with quasi-banking functions (NBQBs). Reservable liabilities include demand, savings, time deposit and deposit substitutes (including long-term nonnegotiable tax-exempt certificates of time deposit or LTNCTDs) The existing reserve requirement ratios vary across bank types and liabilities. The current headline reserve requirement ratio of 12 percent is imposed on certain liabilities of UBs/KBs and NBQBs. Previously, the eligible forms of compliance to the reserve requirements included banks' deposits in their demand deposit account (DDA) with the BSP, reserve-eligible government securities, and vault cash. Effective on the reserve week beginning on 6 April...