Money MarketsSonja JukoDeutsche Bundesbank Center for International C - PDF document

1 Money MarketsSonja JukoDeutsche Bundesba
Money MarketsSonja JukoDeutsche Bundesbank, Center for International Central Bank DialogueStructure, Role & Preconditions for Market DevelopmentDisclaimer: Views expressed are those of the author and do not necessarily represent the view of Deutsche Bundesbank. Motivation & aimpresentationMoney marketsplaya specialrolewitha viewthefunctioningandthedevelopmentfinancialmarketsandthefinancialsystemat largeThe presentationprovidesan overviewkeyconceptualissuesandoffersstructuredoverviewofconstitutingfeaturesmoneymarketsandmoneymarketfunctioningreviewstheroleofmoneymarketsprovidingkeyargumentswhymoneymarketsareimportantandshoulddevelopedDiscussespreconditionsforthedevelopmentofmoneymarketssh

2 eddinglight on relevant areasforaction&#
eddinglight on relevant areasforaction��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development What constitutes a money market?Which subsegmentscan be distinguished? eflection��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Financial Markets Money marketConceptual issues & money market structureFinancial market segment where shortterm financial instrumentswith maturities of up to one year are issued and traded between various market participants��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market develop

3 ment Capital market Maturities 1YMaturit
ment Capital market Maturities 1YMaturities&#x-1.3;&#x 000; 1Y CB Gov OFC NFC Banks Money marketConceptual issues & money market structureMoney market participantsMajor money market participants��Sonja Juko Deutsche Bundesbank ParticipantRoleBanksImportant financial intermediaryin the money marketNeed liquidity to satisfy statutory regulations as well as to be able to cover obligations at any timeCentral Bank (CB)Controlling supplyof CB reserves;Setting policy ratesProvide a platform for clearing and settlementGovernmentIssuerof shorttermsecurities which serve as benchmark and are used as collateralOne of the largest contributor to volatility in liquidityNonfinancial corpo

4 rations (NFCs)May bective as lenders and
rations (NFCs)May bective as lenders and borrowersManaging cashflows (liquidity) Money Markets: Structure, role and preconditions for Market development Whatroledo thedifferent marketparticipantsplay CB Gov OFC NFC Banks Conceptual issues & money market structureMoney market participants & related subsegments��Sonja Juko Deutsche Bundesbank Banks NonBanks Central Bank ��Money Market in itsbroadestsensePrimary Marketof reserves”Redistribution of reservesTrading of shortterm securities & derivativesInterbank Money Marke Money Markets: Structure, role and preconditions for Market development Conceptual issues & money market structureInterbank money marketTh

5 e interbank market is a subsegment and t
e interbank market is a subsegment and the core of money marketsBanks participate in the (interbank) money market …to optimize costs of shortterm fundingminimize opportunity costs of holding liquidityto adjust their liquidity structurein consideration of economic and regulatory requirementsto hedge interest rate risksWhen transactions are settled in CB money, banks effectively exchange CB reserve balances leading to a reallocation of existing CB reserves Demand and supply determine money market rates��Sonja Juko Deutsche Bundesbank Banks ��Redistribution of reservesTrading of shortterm securities & derivativesInterbank Money Market Money Markets: Structu

6 re, role and preconditions for Market de
re, role and preconditions for Market development Conceptual issues & money market structurePrimary market of reservesBanks engagein transactionswithCB manage theirliquidityatisfytheir need of CB reserves by borrowing from the CB paying the prevailing CB (policy) rate to deposit excess reserves at the CB which may or may not be remunerated Transactions between banks and the CB affect the overall level of aggregate reserves (liquidity) in the banking systemInterest ratesaredeterminedbythepolicyratestheoperational proceduressetbytheCB��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Central Bank ��”&#x

7 /MCI; 44;&#x 000;&#x/MCI; 44;&#x
/MCI; 44;&#x 000;&#x/MCI; 44;&#x 000;Primary Marketof reserves” Banks Conceptual issues & money market structureMaturity of transactions: Call vs term money marketExample: US Treasuries��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Call moneymarket Transactions duringthedaywithO/N maturitybybanksandnonbanks Term moneymarket Transactions with maturities of up to one year by banks and nonbanks ��Term moneymarket Various classes of money market instrumentscan meet diverse needs of market participantsConceptual issues & money market structureMoney market instruments & related market segments&#

8 x0000;�Sonja Juko Deutsche Bundes
x0000;�Sonja Juko Deutsche Bundesbank Unsecured market Interbank loans and deposits (Tradable) Shortterm securities, e.g. certificates of deposit (CDs), bills of exchange, commercial papers (CPs) Secured market Repurchase agreements (repos) Swaps against FX Derivatives segment Interest rate swaps Forward rate agreements Futures Options Cash“ segment Money Markets: Structure, role and preconditions for Market development Conceptual issues & money market structureMoney market instruments & related segments: Purpose��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development��−Main goal of market parti

9 cipants using the cash segment is to mai
cipants using the cash segment is to maintainliquidity−−−If the money market is liquid, market participants assume that their demand of shortterm liquidity can be satisfied easily and immediately at any time. This lowers need of market participants to hold precautionary liquidity bufferswhich in turn increases aggregate earnings−−−Cash products enable market participants with a surplus of shortterm deposits to earn an interest−−−Hedging: reduce the risk of adverse price movements in an asset. Primarily, hedging against interest rate risks.−−−Trading: speculating on interest rate changes.−−−Arbitrage: taking advantage of price differences. Cash“segment

10 ��Derivatives segment Conc
��Derivatives segment Conceptual issues & money market structureMoney market instruments: Cash segment OverviewKey characteristicsconventionsmoneymarketinstruments��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Interbank loansdepositsCDsBills exchangeCPsBillsRepos(Main) issuerBanksBanksNFCsNFCs,banksGovernmentBanks,CreditriskIssuerIssuerMitigatedbyreal goodsIssuerIssuerMitigatedbyecuritycollateralInterestCoupon instrumentCoupon instrumentDiscount instrumentDiscount instrumentDiscount instrumentCoupon instrumentQuotationYieldbasisYieldbasisDiscount rateYieldbasisdiscountrateYieldbasisdiscountrateYield

11 basisTradableSecondarymarketYesYesYesYes
basisTradableSecondarymarketYesYesYesYes Money marketsubsegment Broadermoneymarket Broaderinterbankmoneymarket SecondarymarketofCB rerserves Primary marketofCB reserves Issuer Banks/Nonbanks Banks Banks CB Counterparties Banks/Nonbanks Banks Banks Banks Financial instruments (Un)Secured securities & derivatives (up to 1Y) (Un)Secured securities & derivatives (up to 1Y) CB reserves CB reservesConceptual issues & money market structureMoney market segments & market developmentThe moreinstrumentsareissuedandactivelytradedamongdiverse marketparticipantsthemoredevelopedthemarket��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market develop

12 ment Market development Conceptual issue
ment Market development Conceptual issues & money market structureMoney market segments & market development: Status quoin LAC��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development��IToaccessthesurveypleaseopen theweblinkbelow https:// sonjajuko9053.survey.fm/moneymarketstructure ��ILink for moderator: https://crowdsignal.com ��What is the basic structure of the money market in your country? ��NOTE: Chose from the given options and select all that apply SURVEY Conceptual issues & money market structureMoney marketinstrumentsEuro money market Maturity breakdownSource:

13 Euro money market survey (2015)Short mat
Euro money market survey (2015)Short maturitiesmakethebulkthemarket��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development��Maturity breakdown for various money market segments��(percentages of total)��Note: The secured segment consists of daily repurchase agreement transactions only (borrowing and lending) denominated in euro with a maturity of up to and including one year. What characterises an efficient money market?What are measures of market efficiency?Conceptual issues & money market structure ��Sonja Juko Deutsche Bundesbank Reflection Money Markets: Structure, r

14 ole and preconditions for Market develop
ole and preconditions for Market development Conceptual issues & money market structure Money market efficiencyMoney market efficiency typically measured by indicators that are a reflection of the liquidity situation in the money marketbidask spreads volatility of interest rates daily turnoverGenerally speaking, a high daily turnover, narrow bidask spread and low volatility implies ceteris paribus a more efficient marketAnalysingvolatility offers insights into the microstructure of money marketsFor instance, comparing the volatility of interest rates at specific maturities with the average level of volatility across the whole maturity spectrum may allow the to detect atypical movements

15 in some segments of the money market, wh
in some segments of the money market, which, in turn, could be related to imperfections in the market’s structure and might impinge on the effective transmission of the monetary policy impulse��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Conceptual issues & money market structureMoney market efficiency: Euro money market TurnoverTurnoverin specificinstrumentshasevolvedovertime… shedding light on the relative importance of the various money market segmentsWhatexplainsthedevelopmentindividual moneymarketinstrumentsovertime?��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and pre

16 conditions for Market development �
conditions for Market development ��C&#x/MCI; 30;&#x 000;&#x/MCI; 30;&#x 000;umulativequarterly turnover in the euro money market&#x/MCI; 30;&#x 000;&#x/MCI; 30;&#x 000;(EUR trillion)&#x/MCI; 30;&#x 000;&#x/MCI; 30;&#x 000;Note: The secured segment consists of daily repurchase agreement transactions only (borrowing lending) denominated in euro with a maturity of up to and including one year. Conceptual issues & money market structure Definition and market participantsMoney market instrumentsRole of money markets: Why money markets are importantPreconditions for an efficient money market��Sonja Juko Deutsche Bundesbank��Ag

17 enda Money Markets: Structure, role and
enda Money Markets: Structure, role and preconditions for Market development Who needs money markets and why?Role of money markets: Why money markets are important��Sonja Juko Deutsche Bundesbank Reflection Money Markets: Structure, role and preconditions for Market development Role of money markets: Why money markets are importantOverview��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Importancemoneymarkets Financial intermediation Liquidityrisk) management Pricingandfinancingconditions Monetarypolicytransmission Role of money markets: Why money markets are importantFinancial intermediation��

18 000;Sonja Juko Deutsche Bundesbank�
000;Sonja Juko Deutsche Bundesbank��IA deep and liquid (interbank) money market supports financial intermediation function of commercial banks, in particular, the maturity transformationMoney markets improvethefunding base which is a crucial prerequisite for maturity transformationIn emerging and developing economiesthe importance of money markets is more pronounced by the fact that most of the financial sector functions are served by commercial banks��IIn the absence of wellfunctioning money markets, banks may prefer to minimisethe interest rate risk to which they expose themselves when performing maturity transformation by extending variable rate loans to b

19 orrowers onlyAs a result, banks pass on
orrowers onlyAs a result, banks pass on the interest rate risk to borrowers thus creating potential risks for financial stability as interest rate increases can trigger large increase in NPLs as borrowers may become unable to service their debt at higher rates��IIn the absence of money markets, banks lack possibility to manage liquidity risk which can reduce their willingness to hold assets with longer maturitiesAs a result bond market activity and bank lending can be impaired Money Markets: Structure, role and preconditions for Market development Role of money markets: Why money markets are importantLiquidity (risk) management��Sonja Juko Deutsche Bundesbank

20 ��IBanksuse the money mark
��IBanksuse the money market to manage liquidity and to smooth out individual liquidity imbalances which may occur at any time as a result of various liquidity factors��IAbsence of a functioning money marketRenders liquidity management more difficult for banks May encourage hoarding of liquidity (example of Euro area money market)Could force banks to process client transactions with multiday delays so as to find matching transactions within their own client baseCan hamper economic activity as bank intermediation is impaired��IMoney markets serve as medium for cash management for governments��IMoney markets allow financial intermedi

21 ariesto manage liquidity risk attached t
ariesto manage liquidity risk attached to bonds and other term instrumentsBy lowering liquidity risk premiums they enable investors to hold larger portfolios of longerterm instruments and are therefore crucial to stimulate active bond markets. Money Markets: Structure, role and preconditions for Market development Role of money markets: Why money markets are importantPricing and financing conditions��Sonja Juko Deutsche Bundesbank��I(Interbank) money market rates represent the marginal costs of funding for banksand provide benchmarks for the financing conditions throughout the economy Developments in money markets affect the financing conditions faced by NFC

22 s and households ��IBanksr
s and households ��IBanksrely on money market rates in order to price longer term debt as long term interest rates are determined by the current level of shortterm interest ratesexpectations of future shortterm interest rates and risk perceptions (liquidity, credit risk and inflation) ��IIn the absence of a functioning money market, banks have difficulty pricing longer term debt and may be reluctant to lend at longer maturities Money Markets: Structure, role and preconditions for Market development Role of money markets: Why money markets are importantPricing and financing conditions: Yield curveMoney marketratesform theshortend theyieldcurveservereferencepoi

23 ntanchorforlongertermyieldsExpectationsf
ntanchorforlongertermyieldsExpectationsfuturemoneymarketratesguidelongertermyields��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Role of money markets: Why money markets are importantMonetary policy transmissionMoney markets are relevant for CBs as they form the starting point of monetary policy transmission: Changesin monetary policy affect the money market firstMoney markets are of particular importance for CBs which implement monetary policy via an interest rate steering approach ��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development��

24 Chart: The transmissionmechanismfrominte
Chart: The transmissionmechanismfrominterestratesprices Role of money markets: Why money markets are importantMonetary policy transmission: Links to other financial market segmentsMoney marketsegmentsarelinkedwithotherfinancialmarketsegmentsin variousways��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Role of money markets: Why money markets are importantMonetary policy transmission (cont.)��Sonja Juko Deutsche Bundesbank��ISmooth functioning of money markets ensures that the impulse of monetary policy is transmittedalong the yield curve, as longterm rates matter most for economic activity

25 ��IA CB can exert a domina
��IA CB can exert a dominant influence on money market conditions and money market interest rates: Given its monopoly over the creation of CB reserves, a CB can manage the level of CB reserves which serves as ultimate liquidity in the banking system the funding costs for banks Central Bank(Money Market as arena for action)Steers money market interest rates (as operational target) close to policy ratesIs monopoly supplier of CB reserves Money Markets(Money Market as source of information)Transmits policy signalProvides crucial information for monetary policy strategy and monetary policy implementationCoevolution between CB actions and money market development Money Market

26 s: Structure, role and preconditions for
s: Structure, role and preconditions for Market development Role of money markets: Why money markets are importantExcursus: Liquidity analysis, liquidity management & interest rate steeringMoney marketstakecenterstagein liquidityanalysisliquiditymanagementandthesteeringinterestratesbytheCB Poor liquidity analysis and liquidity management by the CB undermines money market functioningSizeable systemwide liquidity surplus removes incentives to transact and need to manage liquidity ��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Liquidity flow Liquidity analysis & projection Liquidity management Liquidity conditions Aut

27 onomous factorsMonetary policy operation
onomous factorsMonetary policy operations Autonomous factorsProjected use of monetary policy instrumentsExcess reserves Actual use of monetary policy instruments Interbank money marketExcess reserves See Annex forbasicinterestrate steeringapproaches Role of money markets: Why money markets are importantMonetary policy transmission: Monetary policy frameworks Whattherolethemoneymarketin different monetarypolicyframeworks? Whattherolethemoneymarketin themonetarypolicyframeworkyourCB?��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development REFLECTION ��Increasingroleofmoneymarketsformonetarypolicytransmission Role

28 of money markets: Why money markets are
of money markets: Why money markets are importantImportancemoneymarkets: OverviewCB perspectivesMoney marketsmatter also forfinancialstability��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Functionofmoneymarketsfroma CB perspectiveHelp in managing liquidityof commercial bankse.g. caused by cash flow mismatches crucialformonetarypolicyandfinancialstabilityHelp in reducing liquidity and interest rate risk of commercial banks e.g.by offering instruments to hedge against and speculate on shortterm interest rate and FX riskscrucial for financial stabilityProvide a source of funding for banks, and other economic agents an

29 d investmentopportunitiese.g. to meet pa
d investmentopportunitiese.g. to meet payment and shortterm financing needs or to profitably invest shorttermcrucial for monetary policyFacilitate pricing signals by setting the marginal cost of funding Developments in money markets affect the financing conditions faced by NFCs and households. Money market rates provide benchmark rates for the pricing of other financial contractscrucial for monetary policyServe as starting point in the monetary policy transmission mechanismcrucial for monetary policy Conceptual issues & money market structure Definition and market participantsMoney market instrumentsRole of money markets: Why money markets are importantFinancial intermediationManaging l

30 iquidityPricing and financing conditions
iquidityPricing and financing conditionsonetary policy transmissionPreconditions for an efficient money market��Sonja Juko Deutsche Bundesbank��Agenda Money Markets: Structure, role and preconditions for Market development What are essential preconditions for efficient money market?Preconditions for an efficient money market��Sonja Juko Deutsche Bundesbank Reflection Money Markets: Structure, role and preconditions for Market development Preconditions for an efficient money marketOverview��Sonja Juko Deutsche Bundesbank Efficient Use of local currency Commitment Sufficient legislation Efficient payment and settlement systems Struc

31 ture & functioning of the banking system
ture & functioning of the banking system of the central bank Money Markets Money Markets: Structure, role and preconditions for Market development��Source: Vavraet al. (2016) Preconditions for an efficient money marketUse of local currency��Sonja Juko Deutsche Bundesbank��IIn principal, money markets can function well using both foreign and local currency��IHowever, it is beneficial to promote and develop money markets in local currencyCB can only reliably perform its function as a monopoly supplier of CB reserves and lender of last resort in local currency, since its stock of foreign exchange reserves is limitedMonetary policy can

32 be implemented in a more straight forwa
be implemented in a more straight forward ways avoiding instruments which may undermine market development further, such as reserve requirements differentiated across currencies, and a set of controls on foreign capital flows��ILocal currency deposits serve as a reliable source of funding safeguarding the liquidity of commercial banksHelps commercial banks in overcoming maturity mismatchesContributes to build trust among banks Money Markets: Structure, role and preconditions for Market development Preconditions for an efficient money marketStructure and functioning of the banking system��Sonja Juko Deutsche Bundesbank��IMoney market development

33 depends on the structure and functionin
depends on the structure and functioning of the banking system��IBanking supervision facilitates the wellfunctioning of money markets by monitoring banks’ business activity and maintaining trust among market participants Money Markets: Structure, role and preconditions for Market development Competition within the banking sector normally leads to lower bidask spreads in money markets, improvements in quality of services through better and faster execution of orders, and a wider range of financial services Ownership of banks State ownership often dampens commercial orientationForeign ownershipof banks can be accompanied by increased efficiency in the money markets as

34 foreign banks bring expertise, corporate
foreign banks bring expertise, corporate governance practices and new and innovative technologyBecause of their recourse to their parent banks foreign owned local banks can tap external liquidity and funding sources Diversity of banks business models Matters as retail banks tend to have liquidity surplus while wholesale banks fund themselves from the money market more often; If banks have similar liquidity needs and fundingsourcesthisreduces activity in the money market, because all participants are on one side of the tradeIf a liquidity is distributed evenly among banks with similar client profile, the only natural counterparty to their liquidity operations is the CB Preconditions for

35 an efficient money marketCommitment of
an efficient money marketCommitment of central bank��Sonja Juko Deutsche Bundesbank��ICBs can create incentives for banks to interact with each other by managing liquidity conditions that encourage interbank transactions and revising its monetary policy operational frameworkLowering the frequency of monetary policy operationsAllowing reserve averaging (which supports the stabilization of money market interest rates��IFurther measures supporting commitment to develop money marketTaking part in developing a secondary market for government securities (e.g. market making) that can provide collateral for money market transactionsPromoting standards,

36 practices, codes of conduct and contrac
practices, codes of conduct and contractual frameworks such as the Global Master Repurchase AgreementEstablishing market infrastructures such as trading platformsAssisting the establishment of money market reference ratesserving as benchmarks Money Markets: Structure, role and preconditions for Market development Preconditions for an efficient money marketCommitment of central bank: Monetary policy frameworksBysteeringshortterm ratesandgivingguidanceforexpected) futureshorttermratesCBs canpromote stablemoneymarketratesandthusstablefundingconditionsPass throughmoneymarketrateslongterm ratescanstrengthenedfurtherbypromotingpricestability, CBs effectivelyreduceinflationriskandthusvolatili

37 tyin fundingconditionsongterm interest r
tyin fundingconditionsongterm interest rates not only reflect investors’ assumptions about future (short term) interest rates but also include a risk premiaassociated with longterm investment, in particular inflation risk as well as credit risk Liquidity premium theory)��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development periodperiodperiod 宅崠the developæµ¥ntf⁲esilient 慮d wellfunctioning 浯ney慲kets is⁤eeply intertwined with the developæµ¥ntf⁡ 浯net慲y⁰olicy fr慭ework⁢慳edn a⁦lexible exch慮ge⁲ate⁡nd 愠pursuitfow⁡nd⁳t慢le⁩nflation 宅崠reforæµ³ focused⁳olely onâ

38 ´he 浯ney慲ket æµ¥ch慮ics⁷ill h
´he 浯ney慲ket æµ¥ch慮ics⁷ill have only limited⁣han捥s of success,⁩f not⁡cco浰慮ied by sust慩ned⁥fforts to⁡chieve low 慮d st慢le⁩nflation using⁡ predict慢le interest rate⁰olicy 慮d 愠relatively⁦lexible exch慮ge rate⸠Source: V慶牡et⁡氮 ( Preconditions for an efficient money marketSufficientlegislation��Sonja Juko Deutsche Bundesbank��ISmooth money market functioning requires specific legislation in various areas which aim to reduce risks and uncertainty and to build trustamong money market participantsBankruptcy procedures Finality of payment and settlement Status and use of collateral��IAbolishlegal co

39 nstrainsfordeposits, interestratesandlen
nstrainsfordeposits, interestratesandlending��ITaxlawdefiningthetreatment of money market activities, including capital gains, (interest) income, and inflation and exchange rate differentials��IReporting requirements promoting greater transparency of money market activities and the compilation of indexes of money market activity and rates can spur the development of money marketsE.g. European Market Infrastructure Regulation (EMIR) aims to make OTC derivatives trading more transparent and secure by requesting standardized derivatives being settled through central counterparties and by reporting all derivative contracts/transactions to trade repositories there

40 by reducing settlement risks and easing
by reducing settlement risks and easing market disruption the event of counterparty default Money Markets: Structure, role and preconditions for Market development Preconditions for an efficient money marketEfficient payment and settlement systems��Sonja Juko Deutsche Bundesbank��IAn efficient payment system infrastructure is indispensable to the efficient functioning of money & capital marketskey function of the payment system is to insure the finality of settlements, so that transactions made over payment networks will be complete and not subject to reversal even if the parties to the transaction go bankrupt or fail after settlement��IReal tim

41 e gross settlement (RTGS)systems provide
e gross settlement (RTGS)systems provide greater assurance of payment finality and uninterrupted financial market operation without netting debits with creditsThe price of lower settlement risk ia larger need for liquidity, which stimulates money market activity��IOversight of payment and settlement systems (typically done by the CB promote safety and efficiency monitoring existing and planned systems, assessing them against these objectives and, where necessary, inducing change Money Markets: Structure, role and preconditions for Market development Preconditions for an efficient money marketStatus quo in LAC countries��Sonja Juko Deutsche Bundesbank Are prec

42 onditions for an efficient money market
onditions for an efficient money market met in your country? Reflection Money Markets: Structure, role and preconditions for Market development Is local currency mainly used?Is the banking system efficient (competition and diversity within the banking sector)?Does the CB create incentives for banks to interact?Does specific legislation ensure smooth money market functioning?Are there wellfunctioning payment and settlement systems (preferablyRTGS)? Preconditions for an efficient money marketWhichfurtheraspectsdo youconsiderasrelevant preconditionforan efficientmoneymarket��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development

43 Reflection Key takeawaysThe moneymarket
Reflection Key takeawaysThe moneymarketa financialmarketsegmentforshortterm maturitiesMoney marketsarethecornerstonean efficientsystemmarketbasedfinancialintermediationAllowcovershortterm liquidityneedsPromote thedevelopmentgovernmentandprivate sectorbondmarketsContributea smooth transmissionmonetarypolicygrowingnumberdifferent issuers, counterpartiesandtypesinstrumentstradedarean indicatorthedevelopmentthemoneymarketDevelopment moneymarketsdependson variouspreconditionsandrequiresa rangepoliciesthatcreateincentivesformarketactivity…in particularforbankskeyfinancialintermediary, activelymanage theirliquidityriskCB operatingproceduresgreatlyinfluencebanks‘incentivesusethemoney

44 market��Sonja Juko Deutsch
market��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development The money and interbank marketReferencesBIS (2017): Repomarketfunctioning, CGFS Paper ECB (2015) Euro Money Market Survey 2015ECB (2015) Euro Money Market Study 2014 EnthoferandHaas (2011): „Treasurer`sHandbookFreixas, Hartmann, Mayer (2008): „Handbook European financialmarketsandinstitutionsVavraet al. (2016) : „Framework fordevelopingmoneymarketsin FrontierandEmerging Market EconomiesThe World Bank (2001): Money MarketsandMonetaryPolicyOperations, in: DevelopingGovernmentBond MarketsA Handbook, Chapter 2, pp. 63The World Bank (2007): Money markets

45 , in: Developingthedomesticgovernmentdeb
, in: Developingthedomesticgovernmentdebtmarket. Fromdiagnosticsreformimplementation. Chapter 2, pp. 7��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development mailonja.juko@bundesbank.deDeutsche Bundesbank ��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development ANNEX��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Money market structureMoney market instruments: Coupon vs discount instruments Coupon instrumentsIssuedwithan interestrate (coupon) at facevalueAt maturity, notionalamountandinteresta

46 repaidbackExamples: Interbank deposits,
repaidbackExamples: Interbank deposits, CDs, Repos Discount instrumentsIssuedwithdiscountfromthenotionalvalueAt maturity, holder receivesnotionalamountDifferencebetweenissuingpriceandrepaymentconstitutesinterestExamples: Commercial papers(CPs), TBills, Bill exchange��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Issue��Repayment��100 + interest IssuediscountRepayment Money market structure Money market instruments: Repurchase agreement (Repo)Visualisationcash flowAgreement in which the seller sells securities (referred to as “collateral”) at a given price, coupled with an agreeme

47 nt to repurchase the securities at a pre
nt to repurchase the securities at a prespecified price at a later point in timeBuyer becomes owner of the collateral and can reuse the collateral, i.e. the collateral is not pledgedDistinction: Cashdriven vs. collateraldriven repo (general and special collateral)Further defining features of reposRepurchase of equivalent securities.Overcollateralization (haircut).Variation margin is required and adds operational burden��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Seller (borrower) Buyer (lender) Initial transaction ��Cash + Interest��SecuritiesCashSecurities Final transaction Repurchase

48 agreement Global Master Repurchase Agree
agreement Global Master Repurchase Agreement as standardized contract jointly developed by the International Capital Markets Association (ICMA, Europe) and the Securities Industry and Financial Markets Association (SIFMA, USAFunction of master agreement is twofold“To facilitate trading by having counterparties agree as many general terms and conditions as possible, in advanceof executing individual transactions.”“To set out clearly the rights and obligations of the counterparties during the lifeof the transaction […] and in the event of a problem arisingWeblink https ://www.icmagroup.org/RegulatoryPolicyandMarketPractice/repoandcollateralmarkets/legal documentation/g

49 lobalmasterrepurchaseagreementgmra Money
lobalmasterrepurchaseagreementgmra Money market structureMoney market instruments: Repurchase agreement (Repo)��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Providing a lowrisk option for cash investmentReverse repos are used heavily by money market funds, asset managers, central counterparties and other institutional investors or corporates as a means of investing their cashTransformation of collateralObtain specific securities or cash to be used in other transactionsSupporting cash market efficiency and liquidityArbitrageurs which are important for price formation extensively use repos to raise cash.Facilitating h

50 edging of riskFunding of hedgingEnabling
edging of riskFunding of hedgingEnabling investors to monetize liquid assetsUnder stress repos provide a means to raise cash without liquidating assetsMoney market structureMoney market instruments: Repurchase agreement (Repo) Economic functions��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development Role of money markets: Why money markets are importantExcursus: The link between short term and long term ratesLongterm interest rates are a geometric average of a given level of shortterm interest rates today, expected future shortterm interest rates (expectations theory) plus a premium which is always positive to cover for risk

51 s inherent in longer term investment Und
s inherent in longer term investment Underlying assumptions: Return of single long term investment should be equal to a sequence of short term investmentsChanges in the current level of short term interest rates and expectations of rising (falling) shortterm interest rates imply an increase (decline) of longterm ratesFuture rates are unbiased estimates of forthcoming spot rates which reflect investors’ expectations of future short term interest rates��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development periodperiodperiod Preconditions for an efficient money marketExcursus: Basics of interest rate steeringDemand for CB

52 reserves and money market rates are inv
reserves and money market rates are inversely relatedDemand forCB reservesdeterminedbyvariousfactorsRequiredreservesset by central bank, i.e. banks are required to hold a certain amount of reserves Settlement requirementsfor interbank transactions settled in central bank reserves Other liquidityneedse.g. partofliquid assetpoolandmeetcash demandNote: Banks do not (cannot) lend out CB reserves to their customers. Technically, they do not need CB reserves to lend as they create a deposit liability on their balance sheet which funds the loanA CB (usually) actsasmonopolysupplierCB reservesandprovideswhatever amount of reserves the banking system demandsCBs manage the level of liquidity by u

53 se of monetary policy instruments which
se of monetary policy instruments which include direct intervention in the money market via open market operations See: Deutsche Bundesbank (2017): The role of banks, nonbanks and the central bank in the money creation process, in: Deutsche Bundesbank Monthly Report April ��Sonja Juko Deutsche Bundesbank Money Markets: Structure, role and preconditions for Market development ��Sonja Juko Deutsche Bundesbank��Preconditions for an efficient money marketExcursus: Steering an operational target rate Money Markets: Structure, role and preconditions for Market development Chart: Steering an operational target rate in a corridor system ��

54 ;Sonja Juko Deutsche Bundesbank�&
;Sonja Juko Deutsche Bundesbank��Preconditions for an efficient money marketExcursus: Steering an operational target rate Money Markets: Structure, role and preconditions for Market developmentChart: Steering an operational target rate in a corridor system with a mechanism that assists the stabilisation of money market rates (e.g. reserve requirements with averaging) ��Sonja Juko Deutsche Bundesbank��Preconditions for an efficient money marketExcursus: Steering an operational target rate Money Markets: Structure, role and preconditions for Market development Chart: Steering an operational target rate in a floor system ��Sonja Juk

55 o Deutsche Bundesbank��Pre
o Deutsche Bundesbank��Preconditions for an efficient money marketExcursus: Steering an operational target rate Money Markets: Structure, role and preconditions for Market developmentChart Steering an operational target rate in a floor system the relationship between shortterm interest rates and excess liquidity, estimation of a logistic function according to Veyruneet al. (2018) BackNoteExcess liquidity at the end of the maintenance period. The EONIA maintenance period average is normalized in a to 1 corridor, representing the spread between the deposit facility rate (0) and the lending facility rate (1).Assumption: the relationship between excess liquidity and shortterm

56 interest rates in a symmetric interest r
interest rates in a symmetric interest rate corridor could be modeledas a bivariate logistic function, which is defined in such a way that shortterm rates converge to the top of the interest rate corridor when excess liquidity is increasingly negative and vice versa.The estimations might help to identify conditions in which shortterm rates become unanchored, that is, they move away from the policy rates and become more volatile within the interest rate corridor defined by the interest rates of the central bank’s standing facilities. Excessliquidtyin EUR NormalizedEONIA ActualObservations2008 Dec2011ActualObservationsJan 2012 Feb 2018 FittedValues 2008 Dec2011FittedValues Jan 2012