Experiences with the monetary transmission mechanism in Poland

1
Adjustment of the NBPs monetary policy
instruments to the requirements of the Eurosystem
Jaroslaw Wisniewski
Narodowy Bank Polski
Belgrade, 19 February 2007
2
DEVELOPMENT OF THE MONETARY POLICY IN POLAND
3
MONETARY POLICY FRAMEWORK IN 1990-1997

• The central bank conducted eclectic monetary
  policy, aiming at
• Limiting the inflation rate,
• Supporting economic growth,
• Financing borrowing needs of the budget.

4
MONETARY POLICY STRATEGY IN 1990-1997
Final target inflation target, agreed by the
Ministry of Finance and the central bank,
accepted by the Parliament Indirect target
money supply (1990 domestic money, 1991-1997
broad money) Operational target 1994-1995
stabilisation of short term interest rates
1996-1997 reserve money Informal (second) target
FX rate.
5
NEW CONSTITUTION AND BANKING LAW (1997)

• Monetary Policy Council (MPC)
• New body responsible for the monetary policy
  framework.
• Introduction Direct Inflation Strategy (1998)
• The full independence of the central bank
• Institutional,
• Functional,
• Financial.

6
MONETARY POLICY FRAMEWORK SINCE 1998

• MPC
• sets NBP interest rates,
• determines the procedures governing the reserve
  requirement and sets the reserve ratio,
• determines the principles of monetary operations,
• Monetary Policy Strategy beyond 2003
• Yearly guidelines of monetary policy

7
MONETARY POLICY STRATEGY SINCE 1998

• The basis of the current monetary policy regime
  is direct inflation targeting
• The permanent inflation target at 2.5 with a
  symmetrical range for deviations of /- 1
  percentage point
• The floating exchange rate system until joining
  ERM II
• Possible foreign exchange interventions under the
  rule of floating exchange rate regime necessary
  for the inflation target implementation

8
LIQUIDITY CONDITIONS IN THE POLISH BANKING SECTOR
9
LIQUIDITY CONDITIONS IN THE BANKING SECTOR

• 1990-1993
• Neutral liquidity conditions, the central bank
  conducts liquidity absorbing and providing
  operations
• Since 1993
• Liquidity surplus, the central bank conducts
  liquidity absorbing operation
• Since 1998
• Liquidity surplus,
• Measures taken by the central bank to limit the
  influence of liquidity factors

10
INCREASE OF LIQUIDITY SINCE 1993

• Direct financing of budget deficit
• Foreign exchange interventions in order to limit
  the pressure on domestic currency appreciation
  (relatively high volume of FX interventions)
• Inflow of foreign currency obtained by the
  Treasury, exchanged at the central bank (e.g.
  funds from privatization)

11
MEASURES TAKEN BY THE CENTRAL BANK TO LIMIT THE
INFLUENCE OF LIQUIDITY FACTORS

• Since 1998, ban on financing the budget deficit
  (new Constitution, new Banking law, New act on
  the NBP)
• Until 2000, the exchange rate framework gradually
  changed from fixed to free-floating.
• Since 1998, the central bank has not intervened
  in the FX market
• In 1999, transaction fixing was discontinued.
• In 2000, the NBP opened the currency account for
  the Ministry of Finance
• The agreement between the NBP and the MF setting
  the limit for buying and selling foreign currency

12
CURRENT LIQUIDITY FACTORS

• After Polands accession to the EU, strong inflow
  of EU funds exchanged mainly at the central bank
• Lower level of Government funds held at the
  central bank (limits since 2005)
• Possible decrease in required reserves ratio
  (from 3.5 to 2.0)

13
LIQUIDITY OF THE BANKING SECTOR(SHORT-TERM
CENTRAL BANK OPERATIONS)
14
FOREIGN RESERVES
15
ADJUSTMENTS OF THE MONETARY POLICY OPERATIONAL
FRAMEWORK TO THE EUROSYSTEM REQUIREMENTS
16
START OF THE PROCESS

• NBP started the adjustment process in 2001
• Improtant role of Plans of activity of the NBP
  prepared on three year basis
• Changes in the framework signalled in the
  preceding year in the Guidelines of the monetary
  policy for the next year.

17
THE ADJUSTMENTS PROCESS
2001 standing deposit facility (second leg of
standing facilities) and intra-day credit in
PLN 2002 regular basic open market operations
(once a week) with 28-day maturity
fine-tuning and structural operations 2003
basic OMOs maturity shortened to 14
days required reserves ratio lowered to
3.5 lump-sum allowance (up to EUR 500
thousand) 2004 remuneration of required
reserves (0.9 of NBPs rediscount rate) 0
ratio from repo transactions
18
THE ADJUSTMENTS PROCESS
2005 basic OMOs maturity shortened to 7
days introduction of POLONIA rate (Polish
OverNight Interbank Average), calculated by the
NBP introduction of limit for Government
deposits held at the central bank 2006
starting publishing liquidity forecasts of the
banking sector once a week in the day of
basic OMO introduction new selection criteria
for OMOs counterparties, fully adjusted to the
Eurosystem requirements.
19
CHANGES IN MP FRAMEWORK
20
MONETARY POLICY INSTRUMENTS
21
NBPS MONETARY POLICY INSTRUMENTS

• Interest rates
• Open market operations
• Reserve requirements
• Standing facilities

22
NBP INTEREST RATES

• The reference rate determines the minimum yield
  obtainable on main open market operations,
  influencing, at the same time, the level of
  interbank deposit rates for comparable maturities
• The lombard rate determines the maximum cost of
  securing funds from the NBP. Thus, it determines
  the ceiling on fluctuations in overnight market
  rates.
• The deposit rate determines the lower limit on
  movements in overnight market rates.

23
OPEN MARKET OPERATIONS
Open market operations are the principal
instrument for maintaining short-term interest
rates at a level consistent with the pursuit of
the MPC established inflation target.
(continued...)
24
OPEN MARKET OPERATIONS
Main operations in the form of issues of 7-day
NBP bills. Tenders for the bills are conducted
on a regular weekly basis, with their minimum
yields set according to the reference rate. The
central bank executes main operations on a scale
allowing it to achieve liquidity balance on the
market, and thus to establish 1-week WIBOR rate
close to the NBPs reference rate.
(continued...)
25
OPEN MARKET OPERATIONS

• Main operations in the form of issues of 7-day
  NBP bills.
• Each bank that meets the criteria specified by
  the central bank is allowed to participate
  directly in main open market operations of the
  NBP. These criteria are
• participation in SORBNET (RTGS system),
• holding an account in the Securities Register,
• having the ELBON application in place, which
  facilitates electronic transfer of orders to the
  NBP.

(continued...)
26
OPEN MARKET OPERATIONS
Fine-tuning operations may be applicable in the
event of unexpected short-term movements in the
liquidity of the banking sector which may lead to
undesirable, from the point of view of monetary
policy, fluctuations in short-term interest
rates. These operations would be both
liquidity-absorbing and liquidity-providing
(issuing NBP money bills, repo and reverse repo
transactions and buying out NBP money bills
before maturity).
(continued...)
27
OPEN MARKET OPERATIONS
Structural operations are aimed to alter the
level of banking sector liquidity in the long
term. Should the need arise, the central bank may
execute the structural operations by issuing
bonds, buying back its own bonds before maturity,
purchasing and selling securities on the
secondary market.
28
REQUIRED RESERVE SYSTEM

• The basic function of mandatory reserve is to
  limit volatility of interest rates by cushioning
  the impact of movements in the banking sector.
• Main features of the required reserve system
• The counterparties of the system are banks
  exclusively ,
• Since October 2003 the uniform ratio is 3.5,
• The length of the maintenance period is
  approximately one month (starting on the last day
  of each month and ending on the day before last
  day of the following month).

29
STANDING FACILITIES
These facilities serve to stabilise the liquidity
level in the interbank market as well as to limit
the fluctuations of overnight interest rates.
Standing facilities are used at the initiative of
commercial banks. Lombard facility enables banks
to take credit on an overnight basis. It is
collateralised by securities and the interest
rate payable on it defines the marginal cost of
securing funds from the central bank. Deposit
facility enables commercial banks to place their
liquidity surplus on a deposit account at the
central bank.
30
EUROSYSTEM FRAMEWORK
31
OPEN MARKET OPERATIONS
Open market operations perform the most important
function in the set of instruments used. They are
used by the Eurosystem for the management of
banking sector liquidity and to steer short-term
market interest rates. The Eurosystem conducts
or may conduct main refinancing operations,
longer-term refinancing operations, fine-tuning
operations and structural operations. By using
main (7-day) operations, the Eurosystem satisfies
approx. 70 of the demand for liquidity of the
euro area banking sector. Longer-term operations
are used to satisfy needs reported for a period
of 3 months (approx. 30 of refinancing funds).
32
OPEN MARKET OPERATIONS
33
REQUIRED RESERVE SYSTEM
The basic function of the required reserve is the
stabilisation of liquidity conditions on the
market (the average basis reduces the volatility
of short-term interest rates). Required reserve
also strengthen sustained shortfalls of liquidity
in the banking sector of the euro area. The ECB
applies uniform non-zero reserve ratio (at
2.0) against most of the items included in the
reserve base. The zero reserve ratio applies
solely to deposits with an agreed maturity over
two years, deposits redeemable at notice of over
two years, repurchase agreements, and debt
securities with an agreed maturity of over two
years.
34
STANDING FACILITIES

• Perform the function of instruments mitigating
  volatility of liquidity conditions on the market
  and stabilising the overnight intererst rate.
• Their remuneration determines the ceiling and the
  floor for the shortest market rates.

35
LIQUIDITY MANAGEMENT

• The strategy of banking sector liquidity
  management implemented by the ECB is based on the
  so-called benchmark allotment, conducted with the
  use of main refinancing operations.
• Daily analysis of liquidity conditions is based
  on the following data provided by national
  central banks (NCBs)
• NCB balance-sheet items as at the previous
  operating day,
• short-term forecasts of the shaping of
  balance-sheet items of a particular NCB.
• While calculating the benchmark allotment, the
  ECB acts under the assumption that the scale of
  the main refinancing operation within its
  maturity period should enable credit institutions
  to maintain funds on the current account at a
  level similar to the required reserve.

36
LIQUIDITY FORECASTS
Once a week, the ECB publishes banking sector
liquidity forecast, which include the maturity
period of main refinancing operations (to be more
precise estimated liquidity needs of the banking
sector for a period of basic OMO maturity).
Liquidity needs are defined as the level of
liquid funds absorbed from the market through the
required reserves and autonomous factors. The
market evaluates such needs and the scale of
liquidity-providing operations in the Eurosystem
on the basis of forecasted average level of
autonomous factors and benchmark allotment,
published by the ECB.
37
COLLATERAL MANAGEMENT FRAMEWORK
Article 18.1 of the Statute of the ESCB allows
the ECB and the national central banks to
transact in financial markets by buying and
selling underlying assets outright or under
repurchase agreements and requires all Eurosystem
credit operations to be based on adequate
collateral. The underlying assets have to fulfil
certain criteria in order to be eligible for
Eurosystem monetary policy operations. The single
framework (Single list) comprises two distinct
asset classes marketable assets and
non-marketable assets. The eligibility criteria
for the two asset classes are uniform across the
euro area. To ensure that the two asset classes
comply with the same credit standards, a
Eurosystem credit assessment framework (ECAF) has
been set up, which relies on different credit
assessment sources.
38
COLLATERAL MANAGEMENT FRAMEWORK
39
FUTURE ADJUSTMENTS AND CHALLENGES
40
NBP vs. EUROSYSTEM
It should be underlined that the current shape of
the operational framework allows the central bank
to conduct the monetary policy in efficient
manner. The central has been gradually
adjusting its framework bringing it very close to
the Eurosystem one. The NBP uses similar
monetary policy instruments as those applied by
the ECB and conducts monetary operations in
similar way.
41
OPEN MARKET OPERATIONS

• The main difference concerns the direction of
  main open market operations. Due to liquidity
  surplus in the domestic banking sector, the NBP
  has to conduct liquidity absorbing operations.
• There are still two important differences between
  the NBP and the ECB
• type of instrument applied (issue of bills in the
  case of the NBP and repo operations or
  collateralised loans in the case of the ECB),
• dates of OMO execution (Fridays NBP, Tuesdays
  ECB).
• The moment of full harmonisation of main
  operations will depend on the liquidity
  conditions in the Polish banking sector.
• Currently, the NBP does not conduct longer
  (3-month) refinancing operations, as is the case
  with the ECB, since there is no need for them.

42
REQUIRED RESERVE SYSTEM

• The required reserves system is highly harmonised
  with the Eurosystem one
• introduction of uniform reserve requirements
  (reduction of the non-zero requirement from
  3.5 to 2 and introduction of 0 reserve
  requirements against liabilities with maturity
  over two years,
• introduction of a uniform maintenance period (it
  is approx. one month in Poland),
• introduction of a uniform lump-sum allowance (it
  amounts to 100 thousand euro in the Eurosystem
  and to EUR 500 thousand in Poland),
• change in the reserve remuneration rate from 0.9
  of the rediscount rate to the average of maximum
  profitability obtained through tenders for main
  operations.

43
COLLATERAL MANAGEMENT FRAMEWORK
Assets deemed eligible by the NBP to
collateralise liquidity providing operations may
currently include only Treasury bills and
Treasury bonds, quoted on the market and
deposited with the National Depository for
Securities or the NBP Securities Register. The
possible future extension of the list of eligible
assets by the NBP will depend on current market
conditions, and particularly on the level of
development of the financial market.
44
CHALLENGES

• End of maintenance period effect and possible use
  of fine-tuning operations
• Possible temporary adjustments of the operational
  framework during the ERM II period
• Liquidity surplus in the banking sector
  possible use of long-term instruments (to achieve
  short-term deficit) vs. waiting till entry to the
  euro-zone.

45
THANK YOU