Oped»
Talking money
AUG 16 -
Doing the necessary liquidity management and ensuring stability in the financial system is the responsibility of the central bank. Adopting an appropriate monetary policy instrument would be essential for addressing the liquidity problem and ensuring the credibility and effectiveness of monetary management. Choosing the wrong instrument, amount and timing could deepen the liquidity problem besides delaying its solution. Nepal’s banking system during the recent period experienced quite an uncomfortable position due to a very tight liquidity situation attributed to a host of reasons.
Take, for instance, the balance of commercial banks’ cash in hand as an immediate indicator of their liquidity. During 2008/09, the percent decline of their cash in hand in comparison to that in the corresponding period of 2007/08 was 30.3 in the first month, 28 in the second month, 15.9 in the fourth month, 13.5 in the fifth month, 12.1 in the sixth month, 11.0 in the seventh month, 9.2 in the eighth month and 2.4 in the ninth month. During the first, second and third months of 2009/10 also, the percent decline in the cash in hand was 2.5, 6.5 and 9.5 respectively. The percent decline was 2.2 in the seventh month, 0.2 in the 10th month and 3.7 in the 11th month.
To regulate such fluctuations and ensure a smooth liquidity position, instruments of open market operations (OMOs) are applied through the collateral or sale/purchase of treasury bills (which have a maturity period of up to one year) issued by the government. For injecting the liquidity, the repo (injection, for a short period, now up to 45 days, the amount of cash credit as determined by Nepal Rastra Bank (NRB) through its estimates and on the basis of the auction among banks and financial institutions (BFIs) to obtain the cash from NRB against the collateral of their treasury bills) and outright sale (injection, for a medium term, now beyond 45 days up to one year, the cash amount as determined by NRB through its estimates and on the basis of the auction among BFIs to sell their specified treasury bills to NRB) have been in operation since 2004/05.
Ironically, there was not a single outright purchase auction in 2008/09. Despite the large shortfall in the cash position as noted above, repos in 2008/09 also amounted to Rs. 11 billion only. During 2009/10, there was only one outright purchase auction amounting to Rs 3.4 billion while repos had amounted to Rs. 131.7 billion. Hence, to address the liquidity problem, there was an exclusive reliance on repos.
The monetary policy for 2009/10 reintroduced the provision of statutory liquidity ratio (SLR) that had been scrapped in 1994, though commercial banks had maintained a far higher portfolio of government securities than prescribed under the SLR. In mid-July 2009, the total holdings by commercial banks of government securities amounted to Rs. 79.5 billion, which represented 14.6 percent of their total deposits (Rs. 545.4 billion). The monetary policy had prescribed the amount of investment in government securities as a percent of the deposits at 6 percent by mid-January 2010 and 8 percent by mid-July 2010. This shows that the SLR provision had becomes redundant. After the introduction of the mandatory provision, the share of the deposits invested in government securities rather fell to 13.5 percent (Rs. 83 billion investments against Rs. 617 billion deposits in mid-July 2010).
Before development banks and finance companies were included as counter-parties for monetary management by involving them in OMOs and standing liquidity facility (SLF) since 2008/09, commercial banks were the only counter-parties when the new monetary management operations were in effect since 2004/05. The outstanding treasury bills in the ownership of commercial banks amounted to Rs. 65 billion in mid-July 2008, Rs. 61 billion in mid-July 2009, and Rs. 68.1 billion in mid-July 2010. Thus, banks were already maintaining an adequate portfolio of government securities also for the purposes of OMOs and the SLF in view of the requirement that the OMOs could be conducted only in treasury bills and that only treasury bills and development bonds could be used as collateral for the SLF (lender of the last resort facility available to BFIs for a period up to five days).
Hence, there was enough holding of treasury bills by commercial banks to enable them to participate in the outright purchase auction. The best liquidity management action on the part of NRB would, therefore, have been to focus on OMOs including conducting outright purchase auctions as part of medium-term liquidity management besides conducting repo auctions as part of short-term liquidity management.
In times of liquidity constraint, there would arise the need for engaging in outright purchase auctions and the SLF for which BFIs would be maintaining the necessary portfolio in treasury bills and other government securities. So, even the SLR provision of the monetary policy for 2010/11 becomes redundant in the present context of OMOs and the SLF. The SLR contradicts the principle of outright purchase auction as BFIs may lose the necessary freedom and flexibility toward engaging in OMOs due to the need for compliance with the irrelevant provision. Such a contradiction should be avoided to ensure compliance with the NRB Act and foster dynamism and efficiency in monetary management. Contradictory regulatory provisions will weaken the financial system and the process of monetary management.
(The author is former executive director, Research Department, Nepal Rastra Bank, and former senior
economic advisor, Ministry of Finance)
Tula Raj Basyal
Posted on: 2010-08-17 08:49
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