Rio de Janerio, December 2014

MACROPRUDENTIAL POLICYMAKING: THE PERUVIAN EXPERIENCE

Paul Castillo B.

Central Reserve Bank of Peru

*The opinions expressed in this presentation correspond to the author and do not necessarily reflect the

position of the Central Reserve Bank of Peru.

Inflation targeting in Peru takes into account the risks that financial

dollarization imposes to financial stability.

2

7

Inflation Targeting

Control of Dollarization Risks

Liquidity Risk :• High reserve requirement on foreign

currency liabilities

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

volatility of exchange rate• Preventive accumulation of international

reserves

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

rate

+

• Limiting the capability of the Central Bank to act as a lender

of last resort in foreign currency.

• Increasing bank’s solvency risk associated to exchange rate

fluctuations.

• Reducing the effectiveness of conventional monetary policy.

Why? Because dollarization affects financial stability through:

3

• Helping banks to internalize dollarization risks

• Reducing the likelihood of spreading the impact of shocks.

• Increasing the capacity of the financial system to absorb

shocks.

Non-conventional policy instruments are intended to reduce these risks

by:

4

Reserve requirements affect credit market conditions by reducing

loanable funds and financial margins, and increasing lending rates

5

Financial mark-up

Interest rate spread

Loanable funds

Liquidity position

Money multiplier

Remuneration

Reserve requirement ratio

Interest rates

Lending and deposits

Aggregatedemand

Inflation

• Preserving the transmission mechanism of monetary

policy during episodes of financial stress. By cutting

reserve requirements a central bank can inject liquidity to the

financial system and reduce pressures over the short-term

interest rate.

• Damping the financial cycle: Higher reserve requirements

increase the cost of financial intermediation for banks, which

leads to an increase in the lending rates.

• Reducing the incentives of banks to intermediate in

foreign currency: By setting higher reserve requirements

rates for liabilities in foreign currency the BCRP increases the

cost of providing loans in foreign currency.

Reserve requirements contribute to reducing dollarization risks by

6

Price stability and high reserve requirement in dollars have

contributed to reduce dollarization of credits.

7

1/ Estimado con el tipo de cambio de setiembre de 2014.

Fuente: Balances de Comprobación.

20

30

40

50

60

70

80

90

En %

Banca: Ratio de Dolarización de los Créditos y Depósitos 1/

Créditos

Depósitos

The scope of use of RR by BCRP has evolved over time. Currently it is used counter-cyclically to dampen the volatility of credit cycles, and differentiated by type of banks liabilities to discourage bank’s external short-term external borrowing and credit dollarization

8

0.0

10.0

20.0

30.0

40.0

50.0

60.0

Reserve requerimests in domestic and foreign currency(As % of total liabilities subject to reserve requirements)

Average required in domestic currency

Marginal requirement in domestic currency

Average required in foreign currency

Higher RR on short-term bank’s external borrowing has lengthen

the average maturity of bank’s external liabilities.

9

32

18

86

47

72

85

75

0

10

20

30

40

50

60

70

80

90

100

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Jan-

07

Mar

-07

May

-07

Jul-

07

Sep

-07

No

v-0

7Ja

n-0

8M

ar-0

8M

ay-0

8Ju

l-0

8Se

p-0

8N

ov-

08

Jan-

09

Mar

-09

May

-09

Jul-

09

Sep

-09

No

v-0

9Ja

n-1

0M

ar-1

0M

ay-1

0Ju

l-1

0Se

p-1

0N

ov-

10

Jan

-11

Mar

-11

May

-11

Jul-

11

Sep

-11

No

v-1

1Ja

n-1

2M

ar-1

2M

ay-1

2Ju

l-1

2Se

p-1

2N

ov-

12

Jan

-13

Mar

-13

May

-13

Jul-

13

External Bank's Liabilities (Balance in US$ million and ratio in percentage

Long term external liabilities Short term external liabilities Long term external liabilities /Total external liabilities

The long term financing increased after the increase in the reserve

requirement for short-term external liabilities.

RR has proven to be effective in reducing the credit cycle,

particularly for small financial institutions

10

.13

.14

.15

.16

.17

.18

.19

.20

.21

.22

4

6

8

10

12

14

16

18

20

22

2006 2007 2008 2009 2010 2011 2012

Liquid assets as proportion of total assetsReserve requirement in domestic currency

Liquid assetss as proportion of total assets and

Reserve Requirements

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

4

6

8

10

12

14

16

18

20

2006 2007 2008 2009 2010 2011 2012

average annual credit growth rate

reserve requirement in domestic currency

Annual growth rate and reserve Requirements

.13

.14

.15

.16

.17

.18

.19

.20

.21

.22

.70

.71

.72

.73

.74

.75

.76

.77

.78

.79

06 07 08 09 10 11 12

Credit as proportion of total assets

Liquid assets as proportion of total assets

Liquid assets and Credit as proportion of total assets

26

28

30

32

34

36

38

40

42

44

.13

.14

.15

.16

.17

.18

.19

.20

.21

.22

06 07 08 09 10 11 12

Liquid Assets as proportion of total assets

Reserve Requirement in Foreign Currency

Liquid assets and Reserve requirments in foreign currency

Macro prudential policy in Peru has successfully smoothed the credit

cycle during the period that followed the quantitative easing of the FED

11

5,4

44,7

25,0

30,0

35,0

40,0

45,0

50,0

-5,0

0,0

5,0

10,0

15,0

20,0

25,0

30,0

35,0

Jan/

07

Apr

/07

Jul/

07

Oct

/07

Jan/

08

Apr

/08

Jul/

08

Oct

/08

Jan/

09

Apr

/09

Jul/

09

Oct

/09

Jan/

10

Apr

/10

Jul/

10

Oct

/10

Jan/

11

Apr

/11

Jul/

11

Oct

/11

Jan/

12

Apr

/12

Jul/

12

Oct

/12

Jan/

13

Apr

/13

Jul/

13

Oct

/13

Jan/

14

Apr

/14

Year-on-year credit growth Average reserve rate

Bank system foreign-currency credit to the private sector and average reserves

• The evidence provided by the Peruvian experience shows

that RR is an effective tool in reducing the trade-offs that

expansionary monetary policies in development economies

are generating the financial systems of emerging market

economies.

• Empirical evidence shows that RR reduce the credit cycle by

increasing lending rates and reducing the supply of credit.

• Central banks need to closely monitor the use of this type of

instrument to minimize its potential costs.

• A close coordination with the regulatory authorities is also

necessary to complement RR with the use of other prudential

instruments such us counter-cyclical provisioning and capital

requirements.

Concluding Remarks

12

Rio de Janerio, December 2014

MACROPRUDENTIAL POLICYMAKING: THE PERUVIAN EXPERIENCE

Paul Castillo B.

Central Reserve Bank of Peru

*The opinions expressed in this presentation correspond to the author and do not necessarily reflect the

position of the Central Reserve Bank of Peru.