31 st october – 2 nd november 2007 1 workshop on developing government bond market 31 october –...

31st October – 2nd November 2007

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Workshop on Developing Government Bond Market31 OCTOBER – 2 NOVEMBER 2007, Bali, Indonesia

Lessons in Monetary Policy Implementation & The Conduct of Monetary Operations Using Government Bonds

Dato’ Ooi Sang KuangBank Negara Malaysia


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OutlineOutline

• 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


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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


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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


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Instrument Mix as at 4th Oct 2007

Direct borrow ing

31%

Commodity Murabahah

3%

BNM Debt Securities -

Conventional18%


Islamic7%

Wadiah11% Others

16%

Repo14%

Range of monetary instruments to sterilise liquidity has been diversified… 2001 vs 2007

Source: Bank Negara Malaysia

Instrument Mix as at end 2001


Conventional14%


Islamic. 2%

Wadiah16%

Direct borrow ing

68%


Total liquidity:

RM46.2 billion Total liquidity:

RM284 billion

Background


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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

USD146.88 billion or 94.8% of GDP.

Greater demand for transparency in monetary policy implementation process and

operations ie: updates on market liquidity.

Background


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OutlineOutline

• Background


• Using Government Bond for Monetary Operations Initial Roadblocks Development Initiatives The effectiveness of repo operations



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Amendments in Central Bank Act was undertaken proactively to overcome impediments to operations…

Effective date Details of amendment Initial 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


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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…



2.00

2.50

3.00

3.50

4.00

4.50

5.00

Oct-02 Feb-03 Jun-03 Oct-03 Feb-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Mar-07 Jul-07

%

2.50

3.50

4.50

5.50

6.50

7.50

%

Overnight rate (LHS) OPR (LHS) 1 Month (LHS)

3 Month Intervention Rate (LHS)

26 April 2004 Introduction of OPR

Ceiling Rate

Floor Rate

BLR (RHS)

ALR (RHS)

ALR vs Prior to 26 April 04 After 26 April 04

Overnight interbank rate -0.01 0.96

3-months intervention rate 0.03 No longer targeted

Correlation analysis on Average Lending Rate (ALR) and interbank rates


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Rapid development of global Islamic financial market leads to the introduction of new instruments…

New Innovation Date Details

Sukuk BNM Ijarah (SBNMI)

Feb- 2006

Sukuk issuance based on the Al-Ijarah or ‘sale and lease back’

concept.

Islamic BN Monetary Notes (BNMN-i)

Dec-2006

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-2007

CMP is a cash deposit product that utilises the Crude Palm Oil based contracts as the underlying assets.

BNMN-Murabahah

Mar-2008

BNMN-Murabahah is essentially a trustee-receipt which utilises Crude Palm Oil (CPO) based contracts as

the underlying assets.

Composition of Islamic Monetary Instruments as at 4th Oct 2007

Commodity Murabahah

3%

BNMN-i & Sukuk BNM

Ijarah7%

Conventional79%

Wadiah11%

Islamic21%



More information on these instruments can be obtained online at BNM’s Islamic Money Market

website at http://iimm.bnm.gov.my/


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OutlineOutline

• Background


• Using Government Bond as Monetary Operations Initial Roadblocks Development Initiatives The effectiveness of repo operations



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Initial roadblocks to the use of government securities for monetary operations….Small BNM holdings of government securities initially impede wider use…

BNM MGS Holdings

0

200

400

600

800

1,000

1,200

1,400

1,600

Mar02

Jun02

Sep02

Dec02

Mar03

Jun03

Sep03

Dec03

Mar04

Jun04

Sep04

Dec04

Mar05

Jun05

Sep05

Dec05

Mar06

Jun06

Sep06

Dec06

Mar07

Jun07

Amount (RM mil)

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.



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Captive market of government bonds…MGS Holdings as at June 07

Non-Residents12%

Others8%

Fin. Institutions15% BNM

1%Insurance Co.

9%

Pension Fund55%

Total : RM188.5 billion

64% of total MGS were hold by “buy-and-hold investors”

Initial roadblocks to the use of government securities for monetary operations….


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OutlineOutline





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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

FundsCollateral 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

http://bondinfo.bnm.gov.my/


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OutlineOutline





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OUTSTANDING MONETARY INSTRUMENTS (JAN 2004 TO EARLY OCT 2007)

-

40

80

120

160

200

240

280

320

Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07

MYR billion

Feb 2004, Introduction of cash driven repo

Apr 2004, Benchmark Repo for Principal dealers

May 2007, Reverse Inquiry Repo

Direct Borrowings

Others

BNM Securities

Repo

Oct 2004, Introduction of ISCAP

Oct 2005, BNM allows Regulated Short-selling

Sterilisation of excess liquidity via repo… more effective, and enhances repo and debt market development

Effectiveness of repo operations


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3.00

3.50

4.00

4.50

5.00

5.50

6.00

6.50

0 1 2 3 4 5 6 7 8 9 10Tenure (year)

Yield %

Trading Yield YTM

Total: 75 tradesAverage deviation from yield curve =13bps

3.00

3.50

4.00

4.50

5.00

5.50

6.00

6.50

0 1 2 3 4 5 6 7 8 9 10

Tenure (year)

Yield %

Traded Yield YTM

Total: 664 tradesAverage deviation from yield curve = 2bps

Repo operations facilitate the smoothening of the yield curve…more bond trades at larger number of points along the government securities yield curve…


Market snapshot of MGS trades from 16 Feb to 29 Feb 2000 Market snapshot of MGS trades from 16 Feb to 28 Feb 2007


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Daily R epo Volume by B NM

0

500

1,000

1,500

2,000

2,500

J an-07 Fe b-07 Mar-07 A pr-07 May-07 J un-07 J ul-07 A ug -07 S e p-07 Oc t-07

A m ount (RM m illion)

C as h driven repo S ecurities driven repo

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.




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Sterilisation costs is lower via repo….

Repo Cost Savings

-

500

1,000

1,500

2,000

2,500

03-Jan 05-Feb 09-Mar 16-Apr 17-May 11-Jun 09-Jul 03-Aug 03-Sep 02-Oct

Amount (RM '000)

0

100

200

300

400Spread (Bps)

Cost Savings (LHS) Spread (RHS)


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



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OutlineOutline





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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

31 st october – 2 nd november 2007 1 workshop on developing government bond market 31 october –...

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