SBP Market Operations And Market Management

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SBP Market Operations And Market Management
by,Muhammad Arif Senior Joint DirectorFinancial
Markets Strategy Conduct Department
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Functions of SBP

• Like any other Central Bank, State Bank of
  Pakistan has its roles and functions to perform.
• State Bank of Pakistan Act 1956 requires the Bank
  to "regulate the monetary and credit system of
  Pakistan and to foster its growth in the best
  national interest with a view to securing
  monetary stability and fuller utilization of the
  countrys productive resources".

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Functions of SBP Contd

• 1st and foremost requirement for monetary
  stability is ensuring price stability, which, in
  State Bank of Pakistan, is achieved through
  stable Interest and Foreign Exchange (forex)
  rates.
• Stability in Interest rates and Forex Markets is
  achieved through intervention in money market and
  forex market, while nature of intervention varies
  in both markets.

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Functions of SBP Contd

• To achieve desired interest rates, SBP uses two
  types of instruments, namely-
• Direct Instruments and
• Indirect Instruments

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Instruments of Monetary Policy

• Direct Instruments
• These are direct controls on the financial
  prices (interest rates) or quantities ( deposits
  or credits) of financial institutions.
• Indirect Instruments
• These influence the behaviour of financial
  institutions by affecting initially the central
  bank's own balance sheet or the pricing (interest
  rates) of central bank facilities, and are used
  mainly in liberalizing or liberalized financial
  systems.

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Direct Instruments

• Direct instruments are typically directives
  given by the central bank to control the quantity
  or price (interest rate) of money deposited with
  commercial banks (and sometimes other financial
  institutions) and credit provided by them.
• Examples of Direct Instruments are
• Interest Rate Controls
• Credit Ceilings
• Directed Lending
• Statutory Liquidity Requirements

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Pros and Cons of Direct Instruments

• Advantages
• They are perceived to be reliable, at least
  initially, in controlling credit aggregates or
  both the distribution and the cost of credit.
• They are attractive to government that wants to
  channelize credit to meet specific objectives.
• They may constitute the most effective or
  practicable approach in circumstances of
  underdeveloped financial markets or where the
  central bank has inadequate techniques of
  indirect monetary control.

• Disadvantages
• Bank-by-bank controls hold back competition in
  financial markets which could benefit both
  borrowers and depositors.
• Selective credit controls-credit controls on some
  banks but not on favored ones, distort markets
  and impose a cost on society.
• Direct controls encourage disintermediation into
  non-controlled markets or abroad. So, overtime,
  they become less effective as lenders and savers
  search for ways to circumvent them.

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Reserve Requirements

• Reserve requirements are the percentage of
  commercial banks liabilities ( or some sub-set
  thereof) which they are required to hold as
  reserves at the central bank. An increase in
  reserve requirements forces the banks to hold
  more balances at the central bank.
• Cash Reserve Requirement (CRR)
• Under this requirement, banks are required to
  keep a weekly average balance of 7 of their
  total demand liabilities with the SBP, subject to
  daily minimum balance of 6 of total demand
  liabilities.

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Reserve Requirements contd
Statutory Liquidity Ratio Commercial banks are
required to keep some fraction of their assets in
the form of cash, Treasury Bills (T-Bills) or
other approved securities. This fraction is
called Statutory Liquidity Ratio. Its main
objective is to ensure that banks have sufficient
funds in the form of liquid assets. Currently
this ratio (excluding Cash Reserve Requirement)
is 18 of time and demand liabilities.
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Indirect Instruments

• SBP uses targeting monetary aggregates for its
  monetary management function, So Indirect
  instruments are used for controlling price or
  volume of the supply of its own liabilities i.e.
  reserve money, which in turn affects interest
  rates and the quantity of money and credit in the
  whole banking system.
• Examples of Indirect instruments are
• T-bill and PIB Auctions
• Open-Market Operations
• Discounting Facility
• Foreign Exchange Management

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T-Bill Auctions

• Treasury bills are sold through auction system
• The cut off yield is determined by the Auction
  Committee, keeping in view monetary targets,
  prevailing economic and financial conditions and
  expected market response. The Six months T-bill
  is considered the most important benchmark by the
  money market and is considered to be the
  signaling tool of SBP for interest rate
  movements.
• T-Bills are issued in 3, 6 and 12 months tenors.

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Procedure of Conducting Auctions

• Auction of MTBs are conducted on alternate
  Wednesdays.
• Selected Financial institutions i.e. Primary
  Dealers are allowed to access the auction.
• Two days prior to conducting of auction MTB
  auction target is announced keeping in view,
  Government borrowing position, SBP monetary
  policy stance and money market situation.
• Two days prior to opening of bids a tender
  Notice, inviting sealed bids in MTB auction, is
  publicized in Newspapers and displayed on Reuters.

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Procedure of Conducting Auctions

• Tender applications are dropped by the PDs in a
  Tender Box upto 11.15 a.m. on Tuesday and
  Wednesday. Sealed bids are opened on Wednesday at
  11.30 am.
• Computer generated detailed bid report is
  prepared. After getting final decision from
  Committee a Press Release of Auction Result, face
  value and discounted value of amount offered and
  accepted along with accepted cut-point and
  weighted average yields are published.

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Pakistan Investment Bond (PIB) Auction

• PIB are issued in tenors of 3, 5, 10, 15, 20 and
  30 years in auctions, according to the quarterly
  targets given by MOF.
• PIBs are sold to meet the GOP long term
  requirements and to provide benchmark rates to
  the Capital Market Transactions.
• 15 days prior to the auction, targets are
  announced on Reuters and sealed bids are invited.
• The 15 days period, i.e. from the day of
  announcement to the auction day, is called short
  selling period.
• Auction committee decides the cut-off yields.

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Open Market Operations (OMOs)

• Using computerized reporting system SBP monitors
  the daily liquidity position of the market and on
  the basis of those reports SBP either injects
  money to the market by lending against collateral
  through reverse repo transaction or by an
  outright purchasing, or mops-up money from the
  market by selling securities or by conducting
  repo transaction.
• OMOs are conducted on as and when market desires.
  Is issued through Reuters and bids are received
  through fax. Only banks are allowed to
  participate in OMOs and T-Bill auctions.

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Discounting Facility (3-Day Repo)

• In Pakistan, SBP has extended a 3-day Repo
  facility to scheduled and investment banks. This
  is an overnight lending facility provided to
  banks, through which SBP provides cash
  accommodation at a penal rate (currently 10 ) to
  any needy bank by undertaking a reverse repo
  transaction with it.
• Cash accommodation is normally for overnight,
  however transaction period can be lengthened to
  3-days or more to cover occasional long
  week-ends.
• SBP also uses changes in discount rate primarily
  as a way of signaling a change in monetary
  policy.

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Exchange Rate Management

• In Pakistan, since 2000, free float regime is in
  place i.e. Exchange Rate is determined on
  supply/demand position of the market.

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Factors requiring Ex. Rate Management

• Appreciation / depreciation of rupee vs.US. in
  interbank market
• Heavy Fluctuation in Forex market in interbank
• Market sentiments
• Heavy payment (Commercial and government)
• Unforeseen events

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Factors Affecting Exchange Rate

• Trade Activities (Imports Exports)
• Foreign Investment (FDI)
• Home Remittances
• Market Saturation
• Political Factors

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Foreign Exchange Transactions

• Ready settlement on the deal date Pakistan
• Value Tom Settlement on next day Canada.
• Spot Settlement usually in two working days
  International standard practice.
• Forward Settlement at some future date ahead of
  the spot

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Foreign Exchange Transactions

• Foreign Exchange Swaps
• Foreign exchange swaps involve the sale purchase
  of foreign currency against domestic currency
  with an agreement to reverse the transaction at
  specified future date on mutually agreed price.
• Sell/Buy Swaps are used to mop up surplus Rupee
  liquidity from the market.
• Buy/Sell Swaps are used to inject Rupee liquidity
  in the market.

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Foreign Exchange Transactions contd

• Forward Transactions
• Outright sale/purchase of a currency against
  another, for settlement at a future date and at a
  predetermined exchange rate.
• Forward rates are quoted as premium or discount
  over spot rate and depend upon the interest rate
  differential of the two currencies.
• Currency having higher interest rate is at
  discount w.r.t. the currency with lower interest
  rate similarly currency having lower interest
  rate is at premium w.r.t. the currency with
  higher interest rate.

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SBPs Intervention in FX Market

• SBP Intervenes
• To maintain stability in the Market
• To ease down market from speculative pressures
• To Stabilize the Exchange Rate
• To fulfill Policy Objectives

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Foreign Exchange Exposure

• This is the possibility of a change in the
  share-holders wealth of a bank arising from a
  movement in the foreign exchange rate.
• There are three ways to calculate foreign
  exchange exposure
• Net Open Position Most liberalized method.
• Summation of LONGS SHORTS Most conservative
  method
• Exposure Limit Moderate Method

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Forex Exposure Limit (FEEL)

• SBP currently uses FEEL to monitor Forex
  positions of commercial banks
• FEEL is calculated on higher of banks
  consolidated short or long positions as maximum
  15 of their total paid-up capital.

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Other Forex Related Functions

• Some other functions SBP performs in order to
  better manage Forex market include
• Off-Site Monitoring
• Daily Rates for Market
• Third Currency activity for GOP payments
• Reserve Management

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• Thank You!