Chapter V. Maturity of Central Bank Securities
- Simon Gray, and Philippe Karam
- Published Date:
- May 2013
A. Objectives of Issuing Central Bank Securities
CB securities are one of the monetary policy instruments used primarily to absorb liquidity in the banking system, when there is a structural (or temporary) surplus of reserve money.66 In a case where supply of reserve money exceeds its demand, CBs which use interest rates as a policy tool need to withdraw the excess amount in order to manage liquidity conditions and so achieve the operating target of monetary policy.67 A tool for draining liquidity—such as the issuance of CB securities—is thus crucial for the conduct of monetary operations and effective liquidity management; this in turn helps enhance monetary transmission, leading to efficient implementation of monetary policy, particularly within an IT framework.
An increasing number of CBs have issued debt securities over the past few years. In emerging economies, continued capital inflows may prompt CBs to intervene in the FX market to curb exchange rate volatility or to slow down the appreciating trend. These CBs may then sterilize a major portion of domestic liquidity injection by CB securities. As for the developed countries where the financial systems were usually in a shortage of liquidity, the so-called quantitative/credit easing measures implemented in an aftermath of the 2008 financial crisis have in some cases led to a large volume of excess reserves in the financial system. Some CBs started to issue, or adjusted the issuance of, debt securities to absorb an amount of reserves deemed excess in the short run, for instance where market dysfunction meant that the CB had to intermediate between banks which were short of liquidity and those which held the excess reserve balances.
There are CBs which issue debt securities for other purposes. For example, the Bank of England issued FX securities to fund its foreign currency reserves, while Bank Negara Malaysia issued its own securities to raise funding for bank recapitalization after the 1997 financial crisis. In addition, some CBs, for instance, the Hong Kong Monetary Authority (HKMA), Bank of Korea (BOK) and Bank of Thailand (BOT), have designed an issuance program of CB securities in a way to help support development of domestic money and bond markets. These CBs announce a regular auction calendar in advance to ensure availability of certain issues and amounts in the market. They also emphasize setting up transparent and market-based auction procedures as well as establishing market infrastructures and entities that foster efficient trading, payment and settlement. In specific cases, the HKMA issues Exchange Fund Bills and Notes with maturities ranging from 91 days to 15 years to establish a reliable benchmark yield curve. The maturity of the BOK’s Monetary Stabilization Bonds is limited to a maximum of two years in order not to collide with the government securities. Similarly, the BOT bills and bonds had different maturities with those of the government, as the CB aimed to provide a variety of debt instruments to boost market activity but without interfering with government debt issuance.
B. Comparing Central Bank Securities with Other Instruments
CB securities offer a number of advantages over certain other monetary policy tools. These include flexibility in terms, and independence from Ministry of Finance issuance plans. They also provide market participants with a fair investment opportunity, and better support market development and liquidity management than term deposits at the CB. This way, the issuance of CB securities helps stimulate the development of interbank money and bond markets.
First, CBs have more flexibility in choosing issuance size and maturity structure, than when using repurchase agreements or relying on the primary issuance of government securities. The issued amount of CB securities is neither constrained by the size of collateral assets in the CB’s portfolio nor depends upon the government’s preferences, unlike the cases of repurchase agreements and reliance on government securities primary issuance, respectively. Notwithstanding, CBs need to take into account the amount of excess liquidity and state of development of the domestic financial markets. CBs can also choose to issue debt securities in certain maturities, generally within the shorter tenors of the yield curve, provided that these are consistent with market preferences and do not collide with government securities issuance.
Second, transparent and market-based issuance procedures, together with the potential for secondary market liquidity, provide fair chances to hold CB securities among banks and possibly also other market participants. Institutions with excess liquidity can decide whether they will invest in CB securities, and in which tenors. This allows an equitable and market-driven distribution of liquidity and CB securities across the financial system, which helps support the pricing process and market mechanisms, especially in countries with underdeveloped financial markets. Direct monetary instruments such as reserve requirements and credit controls are, by contrast, more bluntly imposed on financial institutions.
CB securities are marketable. Given somewhat developed money and secondary bond markets, banks can use CB securities as collateral in repo transactions or sell outright in the secondary bond market. This provides securities’ holders with flexibility in financing options in the future. By contrast, term deposits at CBs are illiquid.
An appropriate design of the securities issuance program helps bolster financial market development. Consistent and predictable auction schedules coupled with regular communication with the market participants allow for better planning of investment strategies, which could lead to a broader investor base and subsequently higher trading liquidity. Besides, the pricing of CB securities can be used to form a risk-free yield curve.
Notwithstanding the aforementioned advantages, CB securities can potentially pose some risks on the CB’s financial position. With their nature of relatively long maturities and the upward-sloping yield curve, costs of issuing CB securities tend to be higher than those of short-term monetary instruments.
Furthermore, CB securities may fragment the public sector debt market if CBs do not coordinate closely with the government in planning the issuance of public sector debt securities. Detailed discussion on this issue is provided in the following section.
C. Designing the Maturity Structure
Three main issues to be considered when designing the maturity structure of CB securities are:
Primary objectives of monetary operations: CBs conduct monetary operations mainly to implement monetary policy, manage liquidity conditions and support market functioning.
The effective implementation of monetary policy requires that monetary operations and instruments be designed to steer market rates in line with an operating target. In a case where a CB uses short-term interest rates as its operating target, the regular keynote operations are typically conducted in the short tenors; that is, those with up to 14-day maturities. Short-term securities should therefore be issued to help steer short-term market interest rates.
Both short-term and long-term instruments can be employed to manage liquidity conditions, depending on the size and nature of the system’s liquidity positions. Longer-maturity securities are normally used to address a structural liquidity surplus stemming from, for example, large and sustained capital inflows and a banking system bailout. Short-maturity securities are generally used to absorb temporary or seasonal surplus liquidity.
To support market functioning and strengthen monetary transmission, longer-dated securities can be issued to convert a structural surplus of liquidity into a deficit. This creates demand for reserve money which helps strengthen the policy rate transmission.
The central bank’s desired liquidity profile
The maturity structure of monetary instruments has implications on the volume and frequency of monetary operations. In principle, CBs need to conduct a substantial volume of monetary operations, in relation to size of the banking system’s balance sheet, at any given time and to operate in the market at sufficiently frequent intervals in order to have significant influence in the market. Insufficient frequency and size may weaken the impact of policy rates, while excessive frequency and size may disrupt market functioning. By shortening/lengthening the maturity profile, CBs may increase/reduce the amount and frequency of their market operations.
To limit the potential overhang of liquidity in order to mitigate exchange rate pressure or prevent the use of liquid assets, CBs can lengthen the maturity structure when withdrawing liquidity from the market.
Market preference on certain maturities
Market preference particularly matters when CBs have to drain surplus liquidity. Unlike where there is a liquidity shortage, banks can choose not to participate in liquidity-draining operations including an auction of CB securities and leave the excess reserves in their current accounts at the CB, if they do not like the instruments and maturities on offer. CBs should carefully analyze the desired liquidity profile of the banking system in order to manage the market liquidity effectively.
There are additional factors relating to the issuance of CB securities.
The maturity of CB securities should be decided primarily in order to achieve efficient liquidity management. It follows that CBs may have to fulfill market appetite at certain maturities in order to absorb a target level of liquidity. There is also an implication that longer-term securities are more likely to be issued when excess liquidity becomes increasingly larger and lasts longer.
Coordination with government securities issuance is important. Maturity profiles should be structured to meet the respective needs of government debt management and CB liquidity management. Normally, CBs focus on the short-end of the yield curve, while the government uses the longer-end. When both agencies issue in a similar segment of the yield curve, there is a case that CB issuance should follow that of the government (e.g., being undertaken the day after government issuance) as the government needs to borrow regardless of market liquidity, whereas the CB’s needs depend on (residual) market liquidity.
CBs should take this opportunity to contribute to market development as long as it does not compromise the primary goal of efficient liquidity management.
Basic features of CB and government securities should be harmonized to avoid fragmenting the market.
Securities should be fungible to increase effective tradable size.
An advance issuance calendar should be published.
Product diversification could also be developed to tap new market segment or when market appetite for currently available products seems to be saturated (although there may be a tension between product diversification on the one hand, and the secondary market liquidity benefits of a smaller number of homogenous securities).
D. Other Considerations
CB securities were sold mainly through multiple-priced auctions and issued with a fixed coupon. Some of the medium-to long-term CB securities offered floating-rate coupons or yields that were indexed to interbank offer rates, or economic variables such as inflation or the exchange rate.
Malaysia and Thailand issued up-to-3 year floating-rate bonds that were linked to KLIBOR and BIBOR fixings, respectively. Peru auctioned a series of 2-month and 3-month bills which was indexed to the market exchange rate. Chile issued inflation-indexed bonds with maturities up to 20 years.
E. Cross-Country Comparison
Around one-third of CBs issue their own securities, mostly to drain excess reserves (from a survey covering 121 CBs as of end-2010). In particular, some AE CBs such as New Zealand and Sweden started to issue securities to sterilize liquidity injection to the banking system during the 2008 financial crisis, whereas a number of emerging market CBs, for example, Korea, Thailand, and Indonesia, have increased the issuance amount to absorb large and sustained capital inflows.
Some CBs issued their debt securities for specific policy goals: for instance, to sterilize the banking sector’s recapitalization in Malaysia, or to finance FX reserves in the United Kingdom.
In addition to the abovementioned countries, several other CBs across different regions of the world had issued securities as for example, Azerbaijan, Georgia, Russia; Afghanistan, Iraq, Jordan, Lebanon, Oman, UAE; Vietnam; Costa Rica, Dominican Republic; Ghana and Mauritius (Table 15).
|Countries||Range of Maturities||Auction Methods||Counterparties|
|Poland||7 days–9 months||Fixed-rate (NBP’s reference rate)||Banks, Bank-guarantee funds, Money market dealers|
|Hungary||14 days||Fixed-rate (the policy rate)||Same as OMOs|
|South Africa||28 and 56 days|
|Georgia||3 months||Multiple-Priced||Commercial Banks|
|(Maximum Bid Rate by NBG)|
|Indonesia||7 days–9 months|
|Peru||2 months–1 year||Multiple-priced||Banks, microfinance inst. insurance co., pension funds, mutual funds, investments funds, deposits insurance funds, public inst.|
|Korea||14 days–2 years||Fixed-rate||Commercial banks and Securities companies|
|Malaysia||44 days–3 years||Multiple-priced||All financial institutions|
|Thailand||14 days–7 years||Multiple-priced auctions for wholesale, Fixed-price tender for retail||Banks and institutional investors for wholesale, Individual for savings bonds|
|Dominican Republic||1 months–7 years||Multiple-priced|
|Costa Rica||1–15 years||Multiple-priced||Stock Brokers only|
|Chile||2–20 years||Uniform-priced||Commercial banks, pension funds, insurance co., mutual fund and stock brokers.|
Most of the CBs issued securities with maturities of no longer than one year. A few CBs issued securities with very short tenors to fine-tune their liquidity management, while others auctioned longer-term securities which reflect largely a high volume of surplus liquidity needing to be absorbed.
Poland and Indonesia issued up-to-7 day CB bills to help manage liquidity in the short-run and withdraw excess reserves that could stem from volatile portfolio inflows or unexpected government spending.
Sweden has issued its 7-day certificates on a weekly basis since October 2008 in order to manage liquidity surplus stemming from crisis-related loans to banks. Between June—October 2010, the certificates with maturities of up to 2 months were issued as a complimentary measure.
New Zealand issued bills with maturities ranging from 1 to 15 months during November 2008—December 2009 to withdraw excess liquidity arising from the use of Term Auction Facility (TAF).
Hungary, South Africa, Georgia, Russia and Indonesia only auctioned CB bills with less-than-1 year maturities, whereas Korea and Malaysia extended the maturities to 2 and 3 years, respectively.
Costa Rica, Dominican Republic and Thailand have maximum maturities of 7 years, while Chile stretched it out to 20 years.
Empirically, CBs determine the maturity structure of debt securities based primarily on needs to absorb surplus liquidity. That is, longer-dated debt instruments are issued to withdraw a structural surplus of long-term nature. A number of CBs also choose to issue certain maturities and design debt issuance plans in order to establish a pricing mechanism and stimulate trading in the money and bond markets. There is in fact no best practice for determining the maturity profile, and a prescription for one country might not work out successfully in another. CBs therefore have to make a decision by taking into consideration various factors in their own jurisdiction, such as nature and amount of surplus liquidity, the existing monetary operations framework and state of market development.
Commercial banks hold balances at the central bank (“reserve money”) to meet reserve requirements, and may hold additional balances for transactions or precautionary reasons. Balances in excess of the reserve requirement plus any additional demanded reserves are defined as excess reserves.
If a central bank is operating a “floor” system, it could use the remuneration rate on excess reserves to steer short-term market rates; but this tends to weaken incentives for market development.