Background
In January 1987, the French monetary authorities replaced the previous mechanism of monetary policy implementation that was based on credit restrictions, quantitative allocations, and administered interest rates with a more market-oriented approach based on instruments aimed at influencing the level of interest rates and on a wider use of reserve requirements. The reforms stemmed from the authorities’ desire to allow market forces to play a greater role in the determination of interest rates and overall credit conditions, complementing the gradual trend toward financial deregulation of the preceding few years.8
Prior to the reform of 1987, the French financial system was rigidly separated, mainly according to the maturity of credit instruments and the type of participants. Strict regulations and barriers divided the financial market into three major segments: the money market (short term), the capital market (long term), and the mortgage market. Each of these segments was regulated by a different authority, with access to each segment restricted to well-defined participants. For example, private nonfinancial firms were not allowed to raise funds or to sell debt instruments in the money market, which was accessible only by credit institutions. This market segmentation prevented the transmission of central bank operations that affected reserves in the interbank market to other financial sectors via interest rate movements. Monetary policy had to be implemented through quantitative credit allocations in order to control liquidity, as measures to influence interest rates would not have been fully effective and, in particular, would not have had the same impact in the different segments of the financial system.
As early as 1969, a report commissioned by the Government expressed the need for reform and modernization of the French financial market. It pointed out explicitly the inefficiency of the French financial system in allocating financial resources to all sectors of the economy, as well as the significant distortions that resulted from the fragmented market. More recently, financial markets were liberalized extensively in the major industrial countries and capital controls were relaxed, with the result that private firms could fund themselves internationally with greater efficiency. These developments further accentuated the imperfections of the French financial system in coping with the needs of the domestic economy in the face of increasing international competition. More specifically, the emergence and rapid development of alternative sources of domestic finance outside or at the margin of “traditional” forms of credit conventionally channeled through commercial banks, as well as the increased opportunities of credit transactions with nonresident financial agents and/or in the international capital market, resulted in a substantial reduction in credit provided by financial intermediaries.9 This in turn weakened the efficiency of the direct instruments of monetary control and rendered a system based on quantitative credit allocation more or less obsolete.
Finally, the need for providing the monetary authorities with adequate tools for effective and flexible short-run control of domestic liquidity became more apparent when in 1979 the EMS was established and the French authorities committed themselves to enhancing the stability of the French franc within the joint floating system. While the participation in the EMS undoubtedly became an important factor in formulating monetary policy, it also affected the mechanism of implementation as it underscored the inadequacy of quantitative credit controls in reacting promptly to fluctuations in the foreign exchange value of the French franc.
In response to these developments, the French authorities implemented in late 1985 substantial structural changes in the financial system, which culminated in 1987 with the adoption of a monetary policy mechanism based on indirect instruments, such as intervention in the interbank market, aimed primarily at influencing the level of interest rates. As a first step, a single, consolidated financial market was developed, which included all maturities, from overnight to long term, and which was open to all economic agents. In December 1985 new financial instruments were introduced, including treasury bills, certificates of deposit, and commercial paper, in order to increase competition and liquidity in the short-term end of the market. Within the broader money market, open to all economic agents, a more restricted market reserved for credit institutions was implemented, thus providing an authentic interbank market, fully sensitive to the interest rate policy of the monetary authorities. Credit allocation and quantitative controls were abandoned on January 1, 1987 and were replaced by a new mechanism for the implementation of monetary policy that operated through the interest rate in the interbank market.10
Policy Formulation, Objectives, and Intermediate Targets
The broad course of monetary policy is established by the Bank of France in concert with the Ministry of Finance as part of the overall budgetary process, with the general goal of fostering growth while maintaining domestic and external balance through price stability and balance of payments equilibrium. Although rapid changes have taken place in the last few years in French financial markets and in the mechanism for the implementation of monetary policy, the authorities have continued to pursue this broad objective by employing monetary aggregates as intermediate targets of monetary policy. Following the reform in 1987, the French Government restated their view that the pursuit of a policy based on targets for the growth in the monetary aggregates remains desirable as a necessary point of reference and guideline for all economic agents.
Targets for monetary growth have been set in France since 1977, although in 1986 several statistical changes were made in order to reflect the changes in the financial market and, in particular, to include the new financial instruments. For 1989, a target range was established for one single aggregate, M211; however, the monetary authorities continue to monitor other aggregates, such as M3, without setting specific target ranges. This choice reflects the view that M2 is largely unaffected by financial innovations, is relatively immune from shifts determined by portfolio choices, and, in particular, is more closely related to the pace of economic activity, as the assets in M2 can be readily converted into means of payment and thus can directly influence domestic expenditures.
The adoption of an implementation mechanism of monetary policy based on interest rates and the participation in the exchange rate mechanism of the EMS, however, have accentuated difficulties in achieving simultaneously domestic and external targets, as the monetary authorities have one instrument to achieve two objectives, namely, the targeted growth in the monetary aggregate and exchange rate stability. In addition, the recent relaxation of capital controls has meant that changes in domestic interest rates can have a substantial, and at times destabilizing, effect on the foreign exchange value of the French franc. The previous system of quantitative credit allocation and capital controls allowed the monetary authorities to maintain administered interest rates at relatively low or stable levels in accordance with the real economy and the external condition, with little effect on the foreign exchange value of the French franc. At present, however, an increase in official interest rates designed, for example, to curb domestic credit expansion could prove to be counterproductive in the short run as it could trigger capital inflows with an undesirable impact on monetary conditions if these inflows were not fully sterilized. The potential exchange rate effect of changes in domestic interest rates has at times resulted in monetary policy being directed less at domestic monetary conditions and more at maintaining the parity of the French franc against the other currencies participating in the EMS. For example, even though growth in M2 was near the bottom of its target range, the Bank of France increased both of its key official interest rates in October and December 1989. These actions were reportedly aimed at alleviating the downward pressure being felt by the French franc vis-à-vis the deutsche mark during this period.
Instruments and Implementation of Monetary Policy
Once the objectives of monetary policy have been determined, the Bank of France conducts and implements monetary policy in the short run. Normally, daily informal meetings are held by the Governor of the Bank of France with one or two Deputy Governors and the Director Generals of the Domestic Capital Markets Department, the Foreign Exchange Market Department, and the Research Department. This group assesses the reserve position of the banking system and evaluates whether current market interest rates, especially the interbank rate, are consistent with the current stance of monetary policy and foreign exchange rates. Instructions are then given to the money market trading room at the Bank of France to intervene in the interbank market on the basis of the evaluations of money market and general macroeconomic conditions. The intervention may simply entail smoothing operations, and as such may not indicate any change in policy. However, conditions may warrant a shift in policy which typically implies a change in one (or at times both) of the two key official interest rates: the interest rate on repurchase tenders (taux des pensions sur appels d’offres), often referred to as the “intervention rate,” and the five- to ten-day repurchase rate (taux des pensions à 5–10 jours).
The Bank of France uses two categories of instruments—official repurchase facilities and open market operations—to implement monetary policy.12 Reserve requirements are also utilized to affect banks’ reserve positions, although on a limited scale. Official repurchase facilities, comprised of periodic repurchase tender offers (opérations sur appel d’offres) made by the Bank of France and a standing five- to ten-day repurchase agreement (pensions à 5–10 jours) facility, are the primary vehicles through which the Bank of France manages reserves in the French banking system. Repurchase tenders are invited solely at the discretion of the Bank of France; that is, the decision to acquire liquidity through this instrument does not rest with the banks. Table 4 summarizes the operations carried out through this facility during the first eight months of 1988. By contrast, the five- to ten-day repurchase agreement is always available to the banks but at a rate of approximately 50–75 basis points higher than the current intervention rate.13
Bank of France: Official Tender Offers, January–August 1988
Bank of France: Official Tender Offers, January–August 1988
| Value Date | Maturity Date | Rate (In percent) | Amount (In billions of French francs) |
|---|---|---|---|
| Jan. 6 | Jan. 19 | 7.50 | 66.3 |
| Jan. 12 | Jan. 26 | 7.50 | 71.2 |
| Jan. 19 | Feb. 2 | 7.50 | 38.7 |
| Jan. 26 | Feb. 9 | 7.25 | 52.1 |
| Feb. 2 | Feb. 17 | 7.25 | 33.5 |
| Feb. 9 | Feb. 24 | 7.25 | 49.4 |
| Feb. 17 | Mar. 4 | 7.25 | 37.5 |
| Feb. 24 | Mar. 11 | 7.25 | 46.1 |
| Mar. 4 | Mar. 23 | 7.25 | 32.7 |
| Mar. 11 | Apr. 1 | 7.25 | 53.4 |
| Mar. 23 | Apr. 12 | 7.25 | 17.6 |
| Apr. 1 | Apr. 12 | 7.25 | 17.6 |
| Apr. 1 | Apr. 20 | 7.25 | 34.8 |
| Apr. 12 | Apr. 29 | 7.25 | 24.7 |
| Apr. 20 | May 10 | 7.25 | 30.3 |
| Apr. 26 | Apr. 29 | 7.25 | 21.9 |
| Apr. 29 | May 20 | 7.25 | 57.9 |
| May 17 | June 1 | 7.25 | 13.6 |
| May 20 | June 1 | 7.25 | 19.8 |
| May 20 | June 10 | 7.25 | 34.4 |
| May 27 | June 10 | 7.00 | 8.1 |
| June 1 | June 22 | 7.00 | 32.1 |
| June 10 | July 1 | 7.00 | 22.6 |
| June 22 | July 11 | 7.00 | 60.6 |
| July 1 | July 19 | 7.00 | 43.8 |
| July 11 | July 29 | 6.75 | 64.4 |
| July 19 | Aug. 9 | 6.75 | 36.5 |
| July 29 | Aug. 17 | 6.75 | 64.3 |
| Aug. 9 | Aug. 26 | 6.75 | 20.4 |
| Aug. 17 | Sept. 5 | 6.75 | 65.6 |
| Aug. 26 | Sept. 13 | 7.00 | 17.0 |
Bank of France: Official Tender Offers, January–August 1988
| Value Date | Maturity Date | Rate (In percent) | Amount (In billions of French francs) |
|---|---|---|---|
| Jan. 6 | Jan. 19 | 7.50 | 66.3 |
| Jan. 12 | Jan. 26 | 7.50 | 71.2 |
| Jan. 19 | Feb. 2 | 7.50 | 38.7 |
| Jan. 26 | Feb. 9 | 7.25 | 52.1 |
| Feb. 2 | Feb. 17 | 7.25 | 33.5 |
| Feb. 9 | Feb. 24 | 7.25 | 49.4 |
| Feb. 17 | Mar. 4 | 7.25 | 37.5 |
| Feb. 24 | Mar. 11 | 7.25 | 46.1 |
| Mar. 4 | Mar. 23 | 7.25 | 32.7 |
| Mar. 11 | Apr. 1 | 7.25 | 53.4 |
| Mar. 23 | Apr. 12 | 7.25 | 17.6 |
| Apr. 1 | Apr. 12 | 7.25 | 17.6 |
| Apr. 1 | Apr. 20 | 7.25 | 34.8 |
| Apr. 12 | Apr. 29 | 7.25 | 24.7 |
| Apr. 20 | May 10 | 7.25 | 30.3 |
| Apr. 26 | Apr. 29 | 7.25 | 21.9 |
| Apr. 29 | May 20 | 7.25 | 57.9 |
| May 17 | June 1 | 7.25 | 13.6 |
| May 20 | June 1 | 7.25 | 19.8 |
| May 20 | June 10 | 7.25 | 34.4 |
| May 27 | June 10 | 7.00 | 8.1 |
| June 1 | June 22 | 7.00 | 32.1 |
| June 10 | July 1 | 7.00 | 22.6 |
| June 22 | July 11 | 7.00 | 60.6 |
| July 1 | July 19 | 7.00 | 43.8 |
| July 11 | July 29 | 6.75 | 64.4 |
| July 19 | Aug. 9 | 6.75 | 36.5 |
| July 29 | Aug. 17 | 6.75 | 64.3 |
| Aug. 9 | Aug. 26 | 6.75 | 20.4 |
| Aug. 17 | Sept. 5 | 6.75 | 65.6 |
| Aug. 26 | Sept. 13 | 7.00 | 17.0 |
The repurchase tender offer is the primary instrument of monetary policy and is the instrument most frequently used by the Bank of France to affect the supply of bank reserves (that is, liquidity of the banking system) and to influence interbank market interest rates. When deemed necessary, early in the morning the Bank of France will invite accredited financial institutions or primary market operators (operateurs principaux du marché—OPM) to submit bids specifying the amount of securities and the interest rate at which they are willing to transact.14 The invitation also specifies the maturity of the securities acceptable for the tender, the date on which the proceeds of the tender will be credited to the account of the bidding institution, and the time period during which the Bank of France will accept bids. After aggregating all of the bids received, the Bank of France normally announces between 1:30 p.m. and 4:00 p.m. the interest rate it has accepted (taux des pensions sur appels d’offres) and the amount allocated to each participant in the tender offer. The following example illustrates a simplified version of bids and the subsequent allocation of reserves to the banking system by the Bank of France through the repurchase tender offers.
Illustrative Example of Bids Received Under Repurchase Tender Offers
(In French francs)
Illustrative Example of Bids Received Under Repurchase Tender Offers
(In French francs)
| Interest Rate (In percent) | From Bank A | From Bank B | Total | Cumulative |
|---|---|---|---|---|
| 8 | 100 | 300 | 400 | 400 |
| 7¾ | 300 | 1,400 | 1,700 | 2,100 |
| 7½ | 1,400 | 500 | 1,900 | 4,000 |
| 7⅜ | 500 | 600 | 1,100 | 5,100 |
| 7¼ | 600 | 700 | 1,300 | 6,400 |
Illustrative Example of Bids Received Under Repurchase Tender Offers
(In French francs)
| Interest Rate (In percent) | From Bank A | From Bank B | Total | Cumulative |
|---|---|---|---|---|
| 8 | 100 | 300 | 400 | 400 |
| 7¾ | 300 | 1,400 | 1,700 | 2,100 |
| 7½ | 1,400 | 500 | 1,900 | 4,000 |
| 7⅜ | 500 | 600 | 1,100 | 5,100 |
| 7¼ | 600 | 700 | 1,300 | 6,400 |
Assume that the Bank of France, after reviewing these bids, decides to set an interest rate of 7½ percent and to allocate F 2,000 of reserves, which is equivalent to 50 percent of the bids received at a rate of 7½ percent and above. Accordingly, it will allocate to Bank A, 50 percent of its bid at 7½ percent and above, or F 900, that is, F 1,800 × 0.5, and to Bank B, 50 percent of its bid at 7½percent and above, or F 1,100, that is, F 2,200 × 0.5. These reserves will be credited to these banks on the predetermined date after verification by the Bank of France of the eligibility of the securities offered as collateral in the repurchase transaction.
The average maturity of the repurchase agreement is about three weeks. The securities that the primary market operators can offer as collateral are treasury bills, commercial paper, and short-term credits denominated in French francs with a maturity not exceeding two years. Commercial paper and short-term credits are subject to evaluation by the Bank of France of the issuing corporation and debtor, respectively. These instruments must be owned by the primary market operator and recorded on its books.
While reserves obtained through repurchase tender offers are provided at the discretion of the Bank of France, the five- to ten-day repurchase agreement facility, the marginal source of funds for banks, is available every business day with no limit on the amount transacted; that is, the decision to borrow rests entirely with the banks with no limit or constraint imposed by the central bank. The request to use this facility is usually conveyed by telephone to the money market room at the Bank of France, specifying the amount and the type of security offered as collateral. Authorized financial institutions and banks always have access to this facility as long as they have an eligible instrument, similar to those eligible for the official tenders, to offer as a collateral. In practice, this facility is utilized by the banks only when the rate in the interbank market is above the rate on the five- to ten-day repurchase agreement. In this case, the excess demand for reserves in the interbank market, which generates the increase in the interbank rate, will be satisfied through this facility. Consequently, the reserves supplied through this facility will tend to alleviate the upward pressure on the interbank rate which, in turn, will tend to return to the rate on five- to ten-day repurchase agreements. It should be noted, however, that interbank market participants may still wish to fund themselves in the interbank market even when the interbank rate exceeds the rate on five- to ten-day repurchase agreements if they expect that the higher interbank rate is only a temporary phenomenon and will last less than the maturity of the repurchase agreement. If this is the case, acquiring reserves by means of the five- to ten-day repurchase agreement would result in a higher effective rate, given the longer maturity of the official repurchase agreement.
The Bank of France may also utilize compulsory reserve requirements to affect banks’ reserve positions in special circumstances. Prior to the reform of 1987, changes in reserve requirements were rarely employed as a direct instrument of monetary policy except in exceptional circumstances when the monetary authorities deemed that other tools would not be sufficient to correct liquidity imbalances. In addition, the relatively small size of the interbank market resulting from the rigid segmentation of the financial market offered little scope for the monetary authorities to utilize compulsory reserve requirements as an instrument to influence short-term liquidity. The volume of reserves was in fact considered insufficient to absorb unexpected fluctuations in the liquidity of the banking system. Following the reform, however, the volume of required reserves was gradually increased in order to facilitate the Bank of France’s management of reserve positions and influence over money market rates. At present, depository institutions are required to hold 5.5 percent of their sight deposits and 3.0 percent of their time deposits with an initial maturity of more than two years in reserve accounts at the Bank of France.15 On January 1, 1987, compulsory reserves on bank lending were completely removed, although the monetary authorities have specified that they retain the right to reintroduce this requirement in exceptional circumstances.
The Bank of France frequently conducts open market operations that are aimed primarily at dampening daily fluctuations in short-term rates; these are by their nature smoothing operations that are not indicative of changes in the underlying policy stance of the Bank of France. These open market operations typically entail a repurchase agreement with a very short maturity (24 to 48 hours), or the outright purchase or sale of treasury bills.
Very short-term repurchase operations of this kind can be carried out with a restricted number of financial institutions if the amounts are small and/or if the monetary authorities do not wish to reveal that the operation has taken place. Alternatively, they may be made public when the amounts transacted are substantial and/or when the Bank of France purposely intends to reveal its objective and its monetary policy stance to the market. According to market sources in France, when these actions become known to the market, they are considered to be extremely efficient in stabilizing market rates, as most market transactions are then carried out at or close to the same rate utilized by the Bank of France in its intervention. In contrast to repurchase transactions, open market operations in treasury bills are always made public in order to differentiate them from the management of the treasury bill portfolio of the Bank of France. However, given the limited size of the French treasury bill market and the modest effect of these operations on other markets, this instrument is utilized infrequently by the Bank of France.
In conclusion, it would appear that the interpretation of intervention by the Bank of France in the interbank market is fairly straightforward. A change in one or both of the official rates—the intervention rate or the five- to ten-day repurchase agreement rate—will generally indicate a significant shift in the underlying stance of monetary policy. Conversely, the announcement of an official tender offer carried out at an unchanged intervention rate or open market operations structured as short-term repurchase agreements or as outright sales or purchases of treasury securities will underscore the intention of the monetary authorities to maintain the interest rate structure and to leave unchanged the stance of monetary policy.
For further discussion of these reforms, see Bruneel (1986) and Truquet (1986).
In the 1970s, financial intermediaries in France provided more than 80 percent of the funds raised by domestic nonfinancial sectors. In 1986, this amount declined to less than 40 percent.
The new procedure is described in Bank of France (1986).
M2 consists of currency, checking accounts, and savings accounts available at sight. M3 consists of M2 plus nonnegotiable time deposits and foreign currency deposits.
The five- to ten-day repurchase agreement is similar to the Lombard facility in Germany.
On average, repurchase tenders are invited each week. They need not, however, result in the net addition of reserves to the banking system as the allocation in the new tender may be insufficient to offset the drainage of reserves caused by the expiration of previous repurchase agreements.