Improving efficiency and limiting risks in interbank markets: the role of central banks Franco Passacantando World Bank Global Payment Systems Conference

Improving efficiency and limiting Improving efficiency and limiting risks in interbank markets: the risks in interbank markets: the

role of central banksrole of central banks

Franco Passacantando

World Bank Global Payment Systems Conference 2009Cape Town, April 8 2009

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NEW TRENDS IN LIQUIDITY CREATION AND CIRCULATION

LIQUIDITY CREATION

Globalization and financial crisis effects on central banks:

enhanced international cooperation

( foreign currency operations and swap operations)

extended scope of existing operations

( massive liquidity injections; new instruments adopted; wider collateral)

unconventional operations

( engagement in the set-up of new market; widening of counterparts)

LIQUIDITY CIRCULATION

- from unsecured to ‘secure’ market venues- from multilateral to bilateral trading


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MONEY MARKET TRADING MODELS

uncollateralized: -bilateral (OTC)

-multilateral (electronic platform e-MID)

collateralized: -bilateral (repo)

-multilateral

(3 main platforms in Europe: Eurex Euro GC

Pooling, MTS repo, ICAP BrokerTec)

Collateral management services Custody

Triparty repo (third agents btw trading parties)


4

INTERBANK MARKET STRUCTURES: e-Mid

Created in 1990 on impulse of Banca d’Italia. It is the only screen-based unsecured money market platform in the world

More currencies gradually introduced. Now deposits in 4 currencies (€, $ USA, GBP and PLN zloty) are traded

Managed by a private company (e-MID SIM S.p.A) owned by 29 banks and by the Italian Banking Association (ABI)

224 participants from 26 countries, including 28 central banks and 2 Ministries of Economy and Finance as observers

Supervised by Banca d’Italia


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INTERBANK MARKET STRUCTURES: collateralized trading venues

EUREX – Euro GC Pooling - Collateralized money market for ECB eligible securities trading. It offers CCP services (Eurex Clearing) and collateral management services (Clearsteam)

CCP : anonymity, minimizing risk, netting

Collateral Management: automated allocation and real-time substitution of securities (virtual collateral pool); re-use of collateral for other money market transactions and/or ECB operations via Clearstream Banking

Trading data: on Feb 2009 Euro GC pooling outstanding volumes at 65 bln (nearly 40 bln in Feb 2008)

MTS – Repo Trading Facility - General collateral trading of securities listed on the MTS markets in transparent and anonymous way via CCP (CCG SpA, LCH.Clearnet SA). Types of contract: Buy-Sell Back for Italian securities and Classic Repo for other countries instruments.

CCP (not mandatory): anonymity, minimizing risk, netting

Trading data: at Feb 2009 GC daily turnover at 40 bln (30 bln in Feb 2008)

ICAP – BrokerTec - Repo trading of a large pool of international securities both in bilateral (transparent) and multilateral (anonymous) CCP assisted segments

CCP: anonymity, minimizing risk, netting

Trading data: at Feb 2009 daily turnover of European repos at 150 bln (around 170 bln in Feb 2008)


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The Eurosystem case:

banks recourse to the standing facilities greatly increased.

A parallel significant increase of the deposit facility

CENTRAL BANKS’ INTERMEDIATION ROLE

Lehman default

Marginal lending facility

Deposit facility

Daily outstanding balances – blns of euro)


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CENTRAL BANKS’ BALANCE SHEET

800

1,200

1,600

2,000

2,400

Jun 07 Oct 07 Feb 08 Jun 08 Oct 08 Feb 09

Lehman default

As a result, the Eurosystem balance sheet has reached unprecedented levels


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UNSECURED MONEY MARKET ACTIVITY HAS SHIFTED …

Activity in the e-MID platform sharply declined, but….

0

5.000

10.000

15.000

20.000

25.000

30.000

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

e-MID

(e-MID: daily average trades - mln of euro)


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… IN FAVOUR OF OTC TRADING...

… Italian banks continued to exchange liquidity on an OTC basis (widely within the group circuits)…

0

5.000

10.000

15.000

20.000

25.000

30.000

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

0

100.000

200.000

300.000

400.000

500.000

600.000

700.000

800.000

e-MID (lhs) interbank stock (rhs) intra-group intb. stocks (rhs)

e-MID: daily average trades; total and intra-group interbank activity of Italian banks: monthly stocks (mln of euro)


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… AND COLLATERALIZED SEGMENTS

.. as well as in the repo segment

0

10.000

20.000

30.000

40.000

50.000

60.000

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

e-MID PCT

e-MID and PCT General Collateral - daily average trades(mln of euro)


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THE INTERBANK COLLATERALIZED MARKET (MIC)

Temporary market segment (operational since 2 February up to 31.12.2009) aimed at overcoming: higher credit and liquidity risk perception through collateralization ‘stigma effect’ associated with funding on the interbank market

through anonymity

In the first two months, 47 banks posted collateral to trade in the MIC;

they account for more than 80% of banks’ consolidated assets

The scheme makes use of the current screen-based trading infrastructures (e-MID) and cash settlement infrastructures (TARGET2)


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FEATURES OF THE MIC

Traded deposits - 1W, 2W, 3W, 1M, 2M, 3M, 4M, 5M, 6M

(possible to insert broken dates in the future)

Participants

Italian and EU banks (understanding with Banca d’Italia is requested)

Anonymity

Participants’ names disclosed neither on trading pages nor on settlement instructions

Guarantee: each participant posts its collateral with the Bank of Italy to cover its own debt position

Mutual loss sharing: for each participant, up to 10% of posted collateral (in case collateral of defaulting bank is not sufficient)

Eligible collateral: assets eligible for the Eurosystem + assets/liabilities guaranteed by Italian & other EU Governments + eligible securities for securities lending at the Banca d’Italia + other financial instruments & credits accepted by Banca d’Italia on a discretionary basis


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FEATURES OF THE MIC

A single real time e-MID and MIC screen for the trader


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- “Facilitator” of trading (ensuring anonymity): Opening of accounts for participants Communication of the amount of the guarantee Possibility to refuse/ask for the substitution of all or part of

the collateral Custody and administration of financial instruments

deposited as collateral Evaluation of collateral reference to market prices (if existent) with a haircut for each category of instrument/asset

Management of defaults

- Supervision Authority

THE ROLE OF BANCA D’ITALIA


15

MIC GROWTH SINCE THE START UP

0

500

1000

1500

2000

2500

3000

3500

4000

4500

mln.

0

5

10

15

20

25

30

35

40

45

50

days

Stocks (lhs) Average duration (rhs)

Activity is largely concentrated (3/4 of the market) on three maturites: 1 week, 2 weeks, 1 month.

But all maturities are quoted during the day


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MIC ACTIVITY IS VARIABLE BUT OVERALL GROWING ...

0

50

100

150

200

250

300

350

400

6-2-09 13-2-09 20-2-09 27-2-09 6-3-09 13-3-09 20-3-09 27-3-09

mln

.

0

2

4

6

8

10

12

average daily values average daily number of contracts

Activity in MIC is approximately equivalent to that on the e-MID on the same maturities

effective demand of collateralized trades


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ISSUES FOR DISCUSSION: what is the proper role for a central bank?

• Dual responsibility of liquidity creation and market development

• MIC is designed to limit risks for central bank and preserve market incentives

• Partial mutual sharing of losses• Losses are very unlikely and would be limited (several

events should simultaneously occurr: default of both the trader and the collateral issuer; insufficient haircuts; insufficient mutual sharing)

• No market maker role for Banca d’Italia. No public subsidy

HENCE: in emergency situations, risks for central banks may be lower than

those of open market operations


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ISSUES FOR DISCUSSION: who should play the role of market catalyst?

Central banks have often played the role of market catalyst. BI has been involved in developing:

-the custodian and SSS operator (Monte Titoli) -the CCP (Cassa di Compensazione e Garanzia) -the Interbank electronic market (e-MID) -the wholesale Government Securities electronic market (MTS) -the cash clearing and settlement systems (at both national and

euro-area level) some of which were later passed on to the market

Alternative approaches: Private market infrastructures, Banking Associations

• there is no optimal approach (local and historical conditions matter)

• depends on the structure of a system (whether few big players dominate the market, or a fragmented system prevails)

• central banks initiatives open to wider access (also greater flexibility in collateral management policy)


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ISSUES FOR DISCUSSION: what model of risk management?

Is there a risk of excessively limiting propensity to take risks?

(collateralized vs uncollateralized; bilateral vs multilateral)• Bilateral monitoring important for market discipline• Uncollateralized contracts are “cheaper” in normal

circumstances

should a move to the generalized adoption of the central counterparty model

be encouraged?• CCPs enhance transparency and standardization• Centralized risk assessment imply economies of scale in risk

management • Most beneficial when operations can be netted

what should be the role of central banks with respect to CCPS

• Need of suspervisory powers• Access to lending of last resort facilities?

Documents

Improving efficiency and limiting risks in interbank markets: the role of central banks Franco Passacantando World Bank Global Payment Systems Conference