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

The monetary policy instruments of the Magyar Nemzeti Bank

MNB, Financial analysis

May 2012

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

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

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


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


Transmission channels: how the monetary policy decisions affect output and inflation

6

Source: Monetary policy in Hungary (2012)


targeting regime



level


their management7

Topics


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


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


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


The standard forint market instruments

OBJECTIVE INSTRUMENT FORM EFFECT

Monetary policy

managementBase rate Two-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 tenderDeposit or

collateralized loan

Management of

unexpected liquidity shocks

11


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


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

Overnight market interest rates within the central bank interest rate corridor

14

0

1

2

3

4

5

6

7

8

9

10

11

0

30

60

90

120

150

180

210

240

270

300

330

05.0

1.20

0904

.02.

2009

06.0

3.20

0906

.04.

2009

08.0

5.20

0910

.06.

2009

10.0

7.20

0911

.08.

2009

11.0

9.20

0913

.10.

2009

13.1

1.20

0915

.12.

2009

18.0

1.20

1017

.02.

2010

22.0

3.20

1022

.04.

2010

25.0

5.20

1024

.06.

2010

26.0

7.20

1026

.08.

2010

27.0

9.20

1027

.10.

2010

29.1

1.20

1029

.12.

2010

28.0

1.20

1101

.03.

2011

01.0

4.20

1104

.05.

2011

03.0

6.20

1106

.07.

2011

05.0

8.20

1106

.09.

2011

06.1

0.20

1108

.11.

2011

08.1

2.20

1110

.01.

2012

09.0

2.20

1212

.03.

2012

13.0

4.20

12

percentageHUF billion

Turnover of unsecured overnight interbank depo transactionsTurnover of overnight interbank repo transactionsInterest rate of overnight interbank repo transactionsInterest rate of unsecured overnight interbank depo transactionsBase rate


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 holding15


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


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


targeting regime



level


their management18

Topics

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 sheetChange of the monthly average statistical balance sheet of the MNB,

January 2008-January 2012, HUF billion

J anuary

2008

J anuary

2012Change

J anuary

2008

J anuary

2012Change

Foreign claims (FX

reserves)4396 11680 7284

Currency in

circulation2166 2796 630

Loans granted to

credit institutions0 26 26 2-week MNB-bill 687 3683 2996

Hungarian

government bond147 169 22

Current accounts of

credit institutions701 468 -233

FX-swaps with credit

institutions0 506 506

O/ N deposits of

credit institutions18 597 579

FX-swaps due to euro

sell tenders0 262 262

FX-swaps with credit

institutions0 506 506

Other assets 126 283 157FX-swaps due to euro

sell tenders0 262 262

Government deposits 452 1439 987

Other liabilities and

equity645 3174 2529

Total assets 4669 12926 8257 Total liabilities 4669 12926 8257

ASSETS LIABILITIES

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)

-1 000

0

1 000

2 000

3 000

4 000

5 000

6 000

7 000

8 000

-1 000

0

1 000

2 000

3 000

4 000

5 000

6 000

7 000

8 000

Janu

ary

2008

Mar

ch 2

008

May

200

8

July

200

8

Sept

embe

r 200

8

Nove

mbe

r 200

8

Janu

ary

2009

Mar

ch 2

009

May

200

9

July

200

9

Sept

embe

r 200

9

Nove

mbe

r 200

9

Janu

ary

2010

Mar

ch 2

010

May

201

0

July

201

0

Sept

embe

r 201

0

Nove

mbe

r 201

0

Janu

ary

2011

Mar

ch 2

011

May

201

1

July

201

1

Sept

embe

r 201

1

Nove

mbe

r 201

1

Janu

ary

2012

Mar

ch 2

012

HUF billionHUF billion

Foreign claims Two-week MNB-bill Deposits of central government

Currency in circulation Other liabilities and equity


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


•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




targeting regime



level


their management23

Topics


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


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


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


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

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

-6

-4

-2

0

2

4

6

8

10

12

-6

-4

-2

0

2

4

6

8

10

1220

00.I II III IV

2001

.I II III IV20

02.I II III IV

2003

.I II III IV20

04.I II III IV

2005

.I II III IV20

06.I II III IV

2007

.I II III IV20

08.I II III IV

2009

.I II III IV20

10.I II III IV

2011

.I II III IV20

12.I

percentagepercentage

Quarterly average inflation Growth rate of currency


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

A jegybank elsődleges célja az árstabilitás elérése és fenntartása. 30

Literature

• Monetary policy in Hungary (2006, 2012)

• 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)

• 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)

• Molnár, Zoltán: About the interbank HUF liquidity - what does the MNB’s new liquidity forecast show? MNB Bulletin (December 2010)

http://www.mnb.hu/Root/Dokumentumtar/MNB/Kiadvanyok/mnbhu_egyebkiadvanyok_hu/Monetaris_politika_2006/monetaris_politika_2006.pdf

http://www.mnb.hu/Root/Dokumentumtar/MNB/Monetaris_politika/mnbhu_eszkoztar/mnbhu_eszkoztar_tanulmanyok/mnbhu_Kezikonyvek/eszkoztar_reszletes.pdf

http://english.mnb.hu/Root/Dokumentumtar/ENMNB/Kiadvanyok/mnben_mnbszemle/mnben_szemle_cikkei/bulletin_2007june_komaromi.pdf




http://www.mnb.hu/Root/Dokumentumtar/MNB/Kiadvanyok/mnbhu_mnbszemle/mnbhu_msz_200706/szemle_2007jun_komaromi.pdf




http://www.mnb.hu/Root/Dokumentumtar/MNB/Kiadvanyok/mnbhu_mnbszemle/mnbhu_msz_200910/balogh_0910.pdf





http://www.mnb.hu/Root/Dokumentumtar/MNB/Kiadvanyok/mnbhu_mnbszemle/mnbhu_msz_201010/varga_mnbszemle_1007.pdf



http://www.mnb.hu/Root/Dokumentumtar/MNB/Kiadvanyok/mnbhu_mnbszemle/mnbhu_msz_201012/molnar.pdf






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

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