An IMF Working Paper entitled “Issuance of Central Bank Securities: International Experiences and Guidelines” by Simon Gray and Runchana Pongsaparn has been released.
Most emerging market central banks (CBs) have a long history of operating in a context of surplus reserve balances. CB balance sheets in these markets have commonly been ‘asset driven’ whereby the CB takes on certain assets—in particular, foreign exchange (FX) reserves, lending to government, or in some cases lender of last resort (LOLR) assistance to weak banks—whether to serve policy goals or for lack of choice. Doing so generates reserve balances in the accounts of commercial banks which exceed the demand for their use. Since excess reserve balances will tend to depress short-term interest rates (and/or lead to exchange rate pressures), many CBs undertake sterilization operations to minimize adverse consequences. This may involve increasing reserve requirements, paying interest on excess reserves, using instruments such as term deposits, reverse repo (or FX swaps), or the issuance of CB bills.
In recent years a number of advanced economy banking systems have moved from a structural deficit of reserve balances to a structural surplus as a result of the Global Financial Crisis (GFC). In Japan, the U.S. and the U.K. CB purchases of securities (Quantitative Easing (QE)) have resulted in substantial balance sheet increases and large excess reserve positions held by commercial banks, while in the euro zone, liquidity provision via lending to banks, in response to the GFC, has also led to excess reserve balances.
In addition, a surge in cross-border capital flows following the GFC has renewed the challenges for emerging market CBs in the effective management of reserve balances. Initially, many emerging market economies experienced capital outflows as financial institutions pulled liquidity back to the U.S. and Europe. The sale of FX by CBs, to smooth exchange rate depreciation, drained excess domestic-currency reserve balances. But shortly thereafter, loose monetary policy (notably QE) in response to the GFC reignited capital inflows into emerging markets, putting upwards pressure on their domestic currencies. To ward off such pressure, FX intervention has been common, causing an increase in domestic currency reserve balances. To avoid an adverse consequence on financial stability, careful management of such balances is essential.
Issuance of CB securities may be an attractive option for effective ‘liquidity management’ as it provides a degree of autonomy to the CB which is not to be available with all other instruments. Issuance of CB securities represents one of the most marketfriendly approaches and can be considered as one of the major open market operation (OMO) tools for several CBs. Direct instruments such as reserve requirements normally act as a tax on financial intermediation via commercial banks, unless they are fully remunerated. In a number of countries, recently introduced constraints on commercial bank intermediation have led to the growth of non-bank channels (sometimes referred to as ‘shadow banking’), with attendant financial stability risks. The use of other OMO (market friendly) instruments – such as the sale of government securities, or using reverse repurchase and FX swaps—relies necessarily on the availability of collateral (or FX) in the CB’s portfolio. CB securities provide a CB with autonomy in this respect. CB securities could also be used to facilitate bond market development purposes. For some countries, a lack of need from the fiscal side may prevent the government from issuing securities in sufficient amount or range of maturities to meet the market demand for domestic currency credit-risk free assets. Issuance of CB securities can fill in the gap and help establish the benchmark yield curve.
This paper seeks to summarize recent cross-country experiences with issuance of CB securities and draw ‘best practices’ that can serve as an operational guideline for CBs. Existing literature on this particular topic has been rather broad in nature, focusing more on the conceptual side of CB securities issuance. This paper attempts to bridge the conceptual and practical aspects of CB securities issuance, covering such issues as differing maturities of issuance, investor access and secondary market trading.
They conclude that CB securities are issued mainly to absorb excess liquidity, and complement other short term market-based liquidity management tools. Recipients of large capital inflows, such as some countries in Asia and Latin America, are more likely to issue CB securities due to the need to sterilize excess liquidity, and able to do so because of a sufficient level of market development. For most countries, CB securities are used to complement other market-based liquidity management tools such as repo and FX swap but tend to substitute for the use of reserve requirement or government securities.
The ISIMP survey also suggests that inflation targeting countries are more inclined to issue CB securities while low-income countries are least likely to issue them. Inflation targeting CBs would require active liquidity management to steer short-term market rates close to the policy target. CB securities can serve as an effective OMO tool in support this objective. On the other hand, the issuance of CB securities by low-income countries may be hindered by high administrative costs, or the lack of a supportive market infrastructure. While the operational details of CB securities issuance differ across countries, the maturities of securities issued tend to concentrate at the shorter segment of the yield curve. There are of course exceptions especially in the case where excess liquidity is structural and there is insufficient government bond supply. Importantly, the plan of CB securities issuance should be closely coordinated with that of the government to ensure consistency and facilitate well-functioning and appropriate development of the sovereign domestic bond market.
The paper also provides some general guidelines on the four major building blocks of CB securities issuance. The guidelines encompass several important steps—from the planning stage (which includes for instance liquidity forecasting, allocation of OMO instruments and market assessment), auction process (whether and how to allow for discretion in the allocation of bids) and post-auction assessment. Drawing on international experiences, these steps provide CBs some guidance on best practices on the operational aspects of CB securities issuance.
Note that IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
