Incorporating Macroprudential Instruments into the ... · PDF fileIncorporating Macroprudential Instruments into the Monetary Policy: ... and 2001 • Recession ... Includes net issuances

Renzo RossiniGeneral ManagerCentral Reserve Bank of Peru

Incorporating Macroprudential Instruments into the Monetary Policy: The Case of Peru

Monetary Policy Workshop on Strengthening the Macroprudential Framework Tokyo – Japan, March 22-23, 2012

Agenda

• Dollarization: The Main Source of Financial Vulnerability

• Monetary Policy Framework

• Macroprudential Framework

• Conclusions

Central Reserve Bank of Peru 2

Dollarization: The main source of financial vulnerability in Peru


Russian crisis

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Dollarization of credit: 1996-2012(% of total credit)

%

%

45 %

Russian crisis

Vulnerabilities associated with financial dollarization

• Solvency Risk: Firms’ balance-sheets deteriorate after a sharp currency depreciation.

• Liquidity Risk: Stress created by runs on deposits and foreign credit lines.

• Bank credit tends to overreact with boom-and-bust episodes.


Financial crisis in Peru after the Russian debt default in 1998

• Sudden stop of short-term foreign liabilities: -50% in August 1999*

• Real currency depreciation: 13% in Aug.1999*

• Increase in non-performing loans in foreign currency: from 5% to 10%

• Credit crunch: growth of credit in foreign currency declined from 26% in Jul.1998 to -4% in Jul.1999. Banking credit started to pick up only in 2002

• Financial crisis: the number of banks fell from 26 to 14, and the number of firms that filled for bankruptcy procedures increased 400% between 1998 and 2001

• Recession: sustained per capita GDP growth resumed only in 2002.


* 12-month rate of change

Agenda




• Conclusions


7

The monetary policy framework in Peru adds to the common features of aninflation targeting regime, a set of measures to deal with the risks offinancial dollarization.

Hybrid Inflation Targeting Scheme

Inflation Targeting

Control of Dollarization Risks

Normal Credit/GDP evolution Liquidity Risk

• Preventive NIR accumulation• Reserve requirement on foreign currency

liabilities

Exchange Risk (Balance Sheet Effect)• Sterilized FX Intervention to reduce

exchange rate volatility

Inflation target : 2% +/- 1%• Operational Target: Overnight interest

rate

+

7

8

Inflation targeting: 2002

The CB recovered its ability to implement a countercyclical monetary policy, usingthe short-term interest rate as its main operational target. Also, the interbankmoney market became a reliable source of funding.

Central Reserve Bank of Peru

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Interest Rate and Inflation Targeting(Figures in percentages)

Interbank Interest Rate

Core Inflation

Upper Bound (Inflation Target)

Lower Bound (Inflation Target)

Lehm

an C

risi

s

Transmission mechanisms of monetary policyThe CB revises every month its operational target and considers unconventionalinstruments in order to preserve the normal transmission mechanisms and toenhance macro-financial stability.

9


Monetary Policy:

Central Bank Operational Instruments

Main Policy Instrument:

Reference interest rate for the interbank

money market

Unconventional quantitative instruments:

Forex interventions, reserve requirements,

structure of the

Central Bank balance sheet

Exchange Rate

Market Interest Rates

Liquidity and Credit

Economic Activity

(Output gap)Inflation

Inflation Expectations

Financial Shocks

Demand Shocks

Supply Shocks

International environment

Public Finances

FOREX intervention

10

FOREX intervention aimed at reducing exchange rate volatility to preventbalance sheet effects, without a commitment to any specific exchange ratelevel or tendency.


-4 000

-3 000

-2 000

-1 000

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FOREX intervention and exchange rate

FOREX Intervention (right axis)Exchange Rate (left axis)

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ma

ncr

isis

Central Reserve Bank of Peru11

• Intervention is aimed at reducing exchange rate volatility without affecting itsfundamental trend.

Rationality of FOREX interventionD

epre

ciat

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90

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Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec

Foreign Exchange Rate Index

(December 2007=100)

Average

Peru

2007 2008 2009 2010 2011

Coefficient of Variation

2006 2007 2008 2009 2010 2011 2012*

Real Brasilero/Dolar 2,5 6,4 15,0 11,4 3,0 5,7 2,5Peso Colombiano/Dolar 4,3 5,2 10,9 9,4 3,4 3,3 2,3Peso Chileno/Dolar 1,7 2,8 14,3 6,6 4,4 4,2 2,3Peso Mexicano/Dolar 2,3 1,1 10,5 4,5 2,1 6,6 2,8Nuevo Sol/Dólar 1,7 2,4 4,2 4,0 0,8 1,3 0,3*Data are as at 9 March 2012

Leh

man

Cri

sis

*

* Average of nominal foreign exchange rates index of other LATAM countries.

The CB follows indicators for the equilibrium real exchange rate to identify any buildup of financial mismatches (created by excessive short-term financing to non-tradable sectors) that can exacerbate the risk of asset bubbles.

Source: BCRP.

12

Real exchange rate aligned with macroeconomic fundamentals


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2007 2008 2009 2010 2011

Real Equilibrium Exchange rate

Model Uncertainty Range

Real Equilibrium Exchange Rate

Multilateral Real Exchange Rate

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The increase in the CB balance sheet has been supported by publicsector deposits, reserve requirements and, to a minor degree, CBsecurities.


Sterilized FX intervention and CB Balance sheet

Assets LiabilitiesInternational reserves 27,6 Public sector deposits 10,5

In domestic currency 6,7In foreign currency 3,8

Reserve requirements 7,6

In domestic currency 2,6In foreign currency 5,0

Central Bank instruments 3,6

Cash holdings 5,7

Other liabilities 0,2

Peru: Central Reserve Bank Balance Sheet

(As percentages of GDP. December 31, 2011)

Reserve requirements on banking liabilities

14

Monetary policy includes, with less frequency, reserve requirement ratios asliquidity management tools to stabilize credit. Additionally, to contain the risksassociated with financial dollarization, the CB applied higher reserve requirementsto FX banks’ liabilities (FX deposits and foreign short-term credit lines)


25%

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r-1

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g-1

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-12

Reserve requirement in domestic currency(In percentages) %

Pre-Lehman

Post-Lehman

Recovery

55%

60%

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Jan

-07

Jun

-07

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-10

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-12

Reserve requirement in foreign currency(In percentages) %

Pre-LehmanPost-Lehman Recovery

Short term credit lines

Deposits

Reserve Requirements as a first line of defense

▫ Higher reserve requirements in domestic currency (from 6% in August 2007 to 25% in August 2008) and foreign currency (from 30% to 49% in the same period)

▫ 120% marginal reserve requirement on liabilities in domestic currency of local banks with institutional non-resident investors

▫ 4% fee on purchases or sales of BCR paper to participants other than local financial institutions

Sterilized FX intervention

▫ Purchases of USD 8,4 billion

▫ Sterilization with central bank certificates and fiscal surplus

Conventional monetary tightening

▫ Increase of the policy rate by 200 bps to 6,5%

Pre-Lehman Policy Actions: August 2007 – August 2008

Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Dec-09 Dec-10 Dec-11

1. Holdings of Central Bank Certificates(Percentage of total)

16,6% 37,6% 40,3% 40,7% 28,5% 1,7% 0,0% 0,0%

2. Holdings of Treasury Bonds in Domestic Currency (Percentage of total)

30,6% 36,4% 35,5% 32,4% 27,1% 19,3% 42,9% 45,4%

3. Investments in the stock exchange market (Percentage of total stocks)

36,5% 40,6% 40,8% 36,1% 34,0% 36,3% 35,0% 30,8%

4. Non-residents deposits in domestic currency in the banking system (12 months percentage variations)

17,6% 964,1% 237,6% 98,2% -12,4% 2,8% 54,4% -1,9%

5. Long PEN FWD position (In millions of US$)

-977 392 1 026 1 094 1 540 10 205 1 925

6. Total holdings (Percentage of GDP) 21,4% 26,9% 22,8% 17,7% 13,6% 18,2% 22,5% 17,2%

Operations of Non-resident Investors

Pre-Lehman Post-Lehman

Reserve requirements

17

The reserve requirement policy favors long-term external funding


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% o

f G

DP

Total Credit and short-term external funding: 1992-2011(As percentages of GDP)

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ssia

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Total credit/GDP

Short-term foreign funding/GDP

International Liquidity and a credible lender of last resort

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48 816

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International Reserves(Millions of US$)

2006 2010 2011

NIR / GDP (%) 19 29 28

NIR / Short-term debt 3 5 6

NIR/ M2 (%) 80 91 91

Prevention is crucial to ring-fence risks. Accumulation of International Reservesprovides a buffer against a sudden stop of external funding


19

Post-Lehman Policy Actions: Crisis management (2008)

Peru: Monetary Operations of the Central Bank (Q_IV-2008)

As percentage of GDP

1. REPO (maturities up to 1 year) 1.5

2. FX Sales1/ 6.2

3. FX Swaps 0.2

4. Reserve Requirements (reduction) 1.4

Total 9.31/ Includes net issuances of exchange rate-indexed Central Bank CDs

The effectiveness of the CB as lender of last resort and liquidity provider, inboth local and foreign currency, is critical to the continuity of the paymentssystem to avoid a credit crunch.


20

Avoiding a credit crunch

A massive CB liquidity injection in local and foreign currencies ensurednormal credit flows after the Lehman crisis.


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3Q-08 4Q-08 1Q-09 2Q-09 3Q-09 4Q-09 1Q-10 2Q-10 3Q-10 4Q-10 1Q-11 2Q-11 3Q-11 4Q-11

Credit to the private sector (Index 2008.3T=100)

Fiscal Support to Macrofinancial stability

21

Fiscal Policy and Public Debt management have contributed to thedevelopment of a local bond market in domestic currency and to anactive liability management, increasing the share of domestic debt inlocal currency.

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Government Bonds Yield Curve 1/

1/ End of period figures

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The yield curve of public bonds is a benchmark to private issuances of longer-term debt at nominal and fixed interest rates, thus reducing the importance of dollar financing . The yields of public bonds in local currency has anchored mortgage rates.

22Central Reserve Bank of Peru

Benchmarking the interest rate of longer-term financing

Agenda




• Conclusions


Macrofinancial frameworkPreventive and proactive policy actions to limit the buildup of systemic financial risks and

to prevent negative impacts on the real sector

Fiscal Policy

Fiscal solvency

Monetary PolicyPrice stability

Macroprudential policy

Preventing systemic financial risks

Microprudential policy

Safety and soundness of institutions to protect

customers

Supervisory Agency

Central Bank

Ministry of Finance

Macroprudential Policy Coordination

Macroprudential Framework: Some general characteristics Objective

• Limiting the build up of systemic financial risks to prevent negative impacts on the real sector and the financial system as a whole

Information, indicators and identification of systemic risks• Time series and cross sectional financial data

• Credit/GDP, leverage indicators

• Stress tests

Instruments to ring-fence systemic risks and to manage residual risks • Reserve requirements, dynamic provisioning, countercyclical risk weights and capital

buffers, time varying LTV ratios, Debt-to-Income and Loan-to-Income caps, time varying limits on currency mismatches, accumulation of international liquidity, and management of the balance sheet of the Central Bank

• Risk of deviating the scope of macroprudential policy tools to other objectives

Governance • Establishment of a clear mandate on preventing systemic financial crisis

• Shared or an independent responsibility: risk of coordination failure

• Prominent role of the Central Bank, given its system-wide view to identify systemic risks associated with its role in the payment system, the money market an the access to financial information

• Without jeopardizing the operational autonomy and independence of the Central Bank


Macroprudential Institutional Framework in Peru• The macroprudential policy tools are managed by different and independent

public agencies

• The CB has as a single aim to attain monetary stability and has a limited set ofpolicies to prevent a systemic financial crisis.

• Informal macrofinancial coordination meetings among the Minister ofFinance, Heads of Supervisory Agencies and the Governor of Central Bank,with support of a Committee of deputies from these institutions.

• Quarterly presentations of the superintendent of banks in the Board of the CBabout financial conditions and risks

• The CB, through its Financial Stability Report, identifies systemic risks andproposes preventive actions to enhance macrofinancial stability, includinginitiatives to develop and enhance the financial infrastructure.

• Residual risk: Coordination failure (information sharing, different perceptionsabout macrofinancial risks, shifting of responsibilities) because of the lack of aclear mandate to preserve macrofinancial stability


Macroprudential indicators

27

To avoid unsustained trends in the Credit/GDP ratio, the CB acts modifying thereserve requirement ratios.


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n-11

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Jul-1

1

Peru: Total credit to the private sector(As percentage of GDP)

Upper limit: +5 % around H_P trend

Credit to private sector/ GDP

Lower limit: -5 % around H_P trend

1/ At constant exchange rate . The trend is calculated using Hodrick Prescott filter.

1/

1/ The trend is calculated unig Hodrick Prescott filter

Macroprudential Indicators

28

1000

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Dec

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sep-

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Real Estate Prices (Apartments)(In 2009 PENs per square meter)

Upper limit: +5 % around H-P trend

Price per square meter

Lower limit: -5 % around H-P trend

The CB also follows trends in the housing market.


Argentina Brasil Colombia Perú Uruguay

30 30 30 21 13

Price/Income ratio (PIR) in the housing market

Source: Global Property Guide, 2011 for all countries except for Peru, which comes from the Central Bank

Cyclical provisions based on GDP growth: November 2008 Additional capital requirements to limit exchange-risk of credits in dollars:

2005 Limits to open FX positions of banks and pension funds Stress tests under adverse macroeconomic scenarios to assess credit

contraction. “War-Games” to assess the degree of coordination among agencies under

stress scenarios. Possible action: additional capital requirement on the excess of L/V ratios.

29

Actions by the Supervisory Agency contain elements of macro-prudential stability


Agenda




• Conclusions


Conclusions

• The macrofinancial stability framework reflects the country’s specificcharacteristics.

• A proper functioning of the transmission mechanisms of monetary policyrequires a sound functioning of the financial system.

• Financial dollarization in Peru warrants the adoption of a macro-financialapproach to policy design.

• Further work is needed to institutionalize the coordination frameworkamong independent public agencies to identify systemic risks, adoptpreventive measures, react promptly to control residual risks during crisisevents, and develop measures to build a solid financial infrastructure.


Documents

Incorporating Macroprudential Instruments into the ... · PDF fileIncorporating Macroprudential Instruments into the Monetary Policy: ... and 2001 • Recession ... Includes net issuances