SBP Market Operations And Market Management

1. SBP Market Operations And Market Management by,Muhammad Arif Senior Joint DirectorFinancial Markets Strategy & Conduct Department

2. 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 country’s productive resources".

3. 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.

4. Functions of SBP Contd… To achieve desired interest rates, SBP uses two types of instruments, namely:- • Direct Instruments and • Indirect Instruments

5. 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.

6. 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

7. 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. Pros and Cons of Direct Instruments

8. 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.

9. 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.

10. 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

11. 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.

12. 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.

13. 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.

14. 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.

15. 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.

16. 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.

17. 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.

18. 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

19. Factors Affecting Exchange Rate • Trade Activities (Imports & Exports) • Foreign Investment (FDI) • Home Remittances • Market Saturation • Political Factors

20. 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

21. 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.

22. 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.

23. SBP’s 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

24. 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

25. 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.

26. 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

27. Thank You!