Appendix IV. Cross-Country Experiences with a Liquidity Surplus

Bernard Laurens
Published Date:
December 2005
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In Mexico, the central bank has been using mandatory remunerated deposits to attain a creditor position in the money market. In 1997, Banco de México’s stance in the money market went from creditor to debtor, essentially due to the considerable amount of foreign assets accumulated in the course of the year. In order to strengthen monetary policy tools, Banco de México’s Board of Directors decided that, as of September 1998, credit institutions would be under obligation to establish deposits at the central bank, with an indefinite maturity. The distribution of such deposits among credit institutions would be conducted according to their total liabilities, and the institutions would be remunerated at the 28-day interbank loan rate. Afterwards, Banco de México would replace any liquidity withdrawn on the grounds of the establishment of said deposits, by means of very short-term open market operations. Using these combined measures, Banco de México moved toward attaining a creditor stance in the money market, allowing for increased control over short-term interest rates.

Spain experienced excess liquidity during 1973-92 due to the Bank of Spain’s (BOS’s) net lending to the government and to capital inflows. Excess liquidity was sterilized to control inflationary tensions, and after Spain joined the EU in 1986, to prevent excessive appreciation of the peseta. The BOS used several nonmarket instruments to generate an operational deficit. Changes in nonremunerated reserve requirements were frequent from 1973 to 1981. By 1978, the authorities had settled on a 5.75 percent ratio and adopted as a principle that the ratios would not be changed for short-run control purposes. However, in 1979, banks were required to place special deposits with the BOS which were remunerated at below-market rates and were replaced later with much higher special remunerated required reserves. After 1990, nonremunerated required reserves were gradually brought down to the current 2 percent level. Remunerated reserve requirements were substituted with mandatory holdings of BOS bonds (at below-market rates). However, there was also room for the use of market instruments.

Systemic liquidity increased in the Netherlands after 1987 due to foreign exchange operations by the De Nederlandsche Bank N.V. (DNB) and decreases in treasury balances. These developments threatened to cause considerable and prolonged money market surpluses, which would have complicated the DNB’s ability to target short-term interest rates and to defend the guilder. To create an operational deficit that facilitated defense of the guilder, the DNB used two instruments: a mandatory market-rate-remunerated deposit facility and the issuance of DNB bills. The deposit facility was introduced in 1988. The amount to be deposited at the facility (money market cash reserve) was fixed at the start of every cash reserve period, based on short-term liabilities. The short period of the facility, one to two weeks, facilitated adjustments to ensure operational shortages. Banks could use the amounts of their individual cash reserve accounts as collateral at the central bank. In 1994, the DNB also started issuing six-month certificates of deposit at market rates to mop up liquidity on a monthly basis.

During the late 1980s and mid-1990s, East Asian countries experienced large capital inflows that were absorbed by a range of sterilization and administrative measures. In 1993, one-third of the net capital inflows into the Asia Pacific Economic Cooperation (APEC) developing countries were absorbed by the central bank in foreign currency reserves. Many APEC countries reduced liquidity in the system by switching government deposits from the commercial banks to the central bank. In Malaysia, the authorities transferred government and public pension fund deposits from the banking system to special accounts in the central bank. Public firms in Indonesia were obliged to convert their commercial bank deposits into Bank of Indonesia certificates. In Thailand, government deposits at the central bank increased from 25 percent of total deposits in 1987 to 82 percent in 1992. Increases in statutory reserves were used in the Philippines, Malaysia, and Korea. Both the Korean and Malaysian authorities also conducted open market operations to sterilize liquidity.

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