International Monetary Fund. Monetary and Capital Markets Department
This Technical Assistance report on Chile constitute technical advice provided by the staff of the IMF to the Banco Central de Chile (BCCh) in response to their request for technical assistance. The BCCh is considering broadening access to its services beyond commercial banks and some Financial Market Infrastructures. The mission emphasized the overarching requirement for all central bank counterparts to be adequately regulated and supervised, to mitigate the central bank’s operational, financial, and reputational risks. Recent changes to the banking law facilitate consolidation of the banking supervisor into the nonbank supervisor. This move should facilitate equal treatment across participants and reduce the prospect of regulatory arbitrage. The new architecture should ease, though not eliminate, coordination efforts between BCCh and authorities when it comes to maintaining financial stability. By applying the assessment framework to Chile, the mission recommended some minor broadening of Nonbank Financial Institutions access to BCCh services, while noting that it should have the power to provide liquidity to any nonbank financial sector to contain spillovers that may otherwise threaten financial stability more generally.
We present a model that describes how different types of bank regulation can interact to affect
the likelihood of fire sales in a crisis. In our model, risk shifting motives drive how banks
recapitalize following a negative shock, leading banks to concentrate their portfolios.
Regulation affects the likelihood of fire sales by giving banks the incentive to sell certain assets
and retain others. Ex-post incentives from high risk weights and the interaction of capital and
liquidity requirements can make fire sales more likely. Time-varying risk weights may be an
effective tool to prevent fire sales.
Market makers learn about asset values as they set intraday prices and absorb portfolio flows. Absorbing these flows causes inventory imbalances. Previous work has argued that market makers change prices to manage incoming flows and offset inventory imbalances. This study argues that they have multiple instruments, or ways to manage inventory imbalances and learn about evolving asset values. Hence, they smooth inventory levels and update prior information about assets using multiple instruments. In ignoring other instruments, previous studies have ignored the information that these provide and overemphasize the role of price changes in inventory management. The model presented here provides new estimates of asymmetric information and inventory effects, the price impact of each instrument, the cost of liquidity, and the impact of an intervention on these costs.