Development of Money Markets

1
Development of Money Markets

• Mats Filipsson
• International Monetary Fund
• Monetary and Financial System Department
• Workshop on Developing Government Bond Markets in
  Sub-Saharan Africa
• Johannesburg, June 17-19, 2003

2
Overview of Presentation

• Benefits of money markets
• Conditions for money market development
• Role of central bank in developing money markets
• Coordination between monetary operations and
  government cash management

3
Benefits of Money Markets

• Promote financial stability and development
• Financial institutions can cover their short-term
  liquidity needs
• Facilitate development of a liquid bond market
• Reason Enable to obtain regular financing of
  bond inventories to carry out their market making
  function

4
Benefits of Money Markets (cont.)

• Consequentlymoney markets could help to
• Reduce the need to use monetary financing /
  foreign currency debt
• Reduce the cost of government financing (lower
  liquidity premium)

5
Benefits of Money Markets (cont.)

• Moreover.. effective monetary policy
• First step of transmission of monetary actions to
  economy
• Money market rates are a useful indicator of
  expectations regarding future monetary actions

6
Conditions for Money Market Development

• Conditions for developing a well-functioning
  money market
• Financial institutions commercially motivated to
  to actively manage risk and maximize profits.
• Sound financial institutions.
• Use of indirect monetary policy instruments.
• Sound government cash management and good
  coordination.

7
Role of the Central Bank

• Stability oriented monetary policy
• Liquidity management of central bank
• affects the stability of the money market
• and
• the incentives to use the money market to manage
  risk

8
Role of the Central Bank (cont.)

• Standing facilities
• penalty rates should provide incentives for
  interbank activity
• wide enough corridor should encourage trading

9
Role of the Central Bank (cont.)

• Open market operations
• foster the development of secondary markets
• foster collateralized money markets (repos,
  buy/sell backs)
• Need for coordination

10
Role of the Central Bank (cont.)

• Reserve requirements
• Trading in overnight market will be influenced by
• Length of reserve maintenance period
• Averaging provisions for meeting reserve
  requirements

11
Role of the Central Bank (cont.)

• Importance of accurate liquidity forecasts
• Liquidity management decision are based on
  liquidity forecasts
• Govt. cash flows large impact on the autonomous
  component of liquidity supply
• Often difficult to predict govt. cash flows

12
Coordination between monetary operations and
govt. cash management

• Government cash flows often unpredictable
• can be a major source of uncertainty in liquidity
  management
• adds volatility
• To reduce volatility
• Coordination central bank ? government
• Effective information-sharing and coordination
  between CB, MoF, and debt managers is critical
  (see Guidelines for Public Debt Management)

13
Coordination between monetary operations and
govt. cash management (cont.)

• Ways of coordination
• CB acts as fiscal agent information of debt
  calendar is available.
• Govt. shares cash flow projections with CB on a
  daily basis and promptly informs about new
  information (liquidity-forecasting committee can
  be useful).
• Uncertainty is reduced when overdraft is limited
  or prohibited and govt. deposits not held with CB
  (but problem when banks are weak).

14
Summary

• Factors for money market development
• Profit oriented and sound banks
• Monetary operations through market based
  instruments
• Incentive structure for interbank trading
  provided through CBs operating procedure
• Coordination between government cash management
  and monetary operations

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Stylized balance sheet of the central bank

• Supply of bank reserves NFA NPG OIN C
  L

Assets Liabilities
Net foreign assets (NFA) Currency (C)
Net position of the govt. (NPG) Bank reserves (R)
Lending to banks (L)
Other items net (OIN)
Policy position
Autonomous position
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Repurchase Transactions (Repos)

• Definition A repurchase transaction involves a
  buyer" agreeing to buy securities from the
  seller for a certain price at a certain time
  and, also, agreeing to sell those same securities
  back to the seller at some future point, at an
  agreed price and seller agreeing to pay interest
  at specified rate on sales amount between initial
  sale and repurchase dates.

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Master Repurchase Agreement

• Definition A master repurchase agreement is a
  single document signed between two counterparties
  for the purpose of conducting repurchase
  transactions. It sets out rights and obligations
  of each party. Advantages include netting legal
  effect of which is to aggregate all deals
  transacted between the two parties and to treat
  them as one