Bank for International Settlements, 2008, “Principles for Sound Liquidity Risk Management and Supervision,” Basel Committee on Banking Supervision, available at http://www.bis.org/publ/bcbs144.htm.
Boyd, John, Gianni De Nicolo, and Abu Jalal, 2009, “Bank Competition, Risk, and Asset Allocations,” IMF Working Paper 09/143 (Washington: International Monetary Fund).
Chailloux, Alexandre, Simon Gray, Ulrich Klüh, Seiichi Shimizu, and Peter Stella, 2008, “Central Bank Response to the 2007–08 Financial Market Turbulence: Experiences and Lessons Drawn,” IMF Working Paper 08/210 (Washington: International Monetary Fund).
Counterparty Risk Management Policy Group, CRMPG III, 2008, “Containing Systemic Risk: The Road to Reform” available at http://www.crmpolicygroup.org/.
Institute of International Finance, 2008, “Market Best Practices: Principles of Conduct and Best Practice Recommendations—Financial Services Industry Response to the Market Turmoil of 2007-2008,” available at www.ieco.clarin.com/2008/07/17/iff.pdf.
International Monetary Fund, 2004, “Republic of Croatia: Selected Issues and Statistical Appendix,” IMF Country Report No. 04/251, available at http://www.imf.org/external/pubs/ft/scr/2004/cr04251.pdf.
Appendix 1. Data Appendix
The authors are grateful to Klaus Enders, Simon Gray, Karl Habermeier, Gene Leon, Ananthakrishnan Prasad, Gabriel Sensenbrenner, and Torsti Silvonen for helpful comments.
The liquidity crisis in 2008 exposed financial vulnerabilities of the Dubai government and quasi-government entities. The vulnerabilities were caused by their heavy reliance on borrowing from abroad and large refinancing needs.
The Abu Dhabi government is the largest recipient of oil revenues. The development of a Treasury bond market could, therefore, be seen as helping to ensure that the financing needs of the various levels of government (federal and emirates) are met. A mechanism would need to be devised by which the various fiscal entities coordinate the financing of their respective fiscal positions given their different sources of revenues and that their financing needs will vary over time and across the emirates and federal government.
Daily offers from ten banks (of which 5 are local) contribute toward the determination of the U.A.E. interbank offer rate.
The Federal Reserve established temporary liquidity swap facilities with the following central banks: Banco Central do Brasil, the Banco de Mexico, the Bank of Korea, and the Monetary Authority of Singapore. These new facilities amounted to $30 billion for each signatory.
This point is also made in a compelling fashion in the 1.2008 report of the Counterparty Risk Management Policy Group. The report emphasizes that to the extent that capital adequacy and rigorous stress-testing of liquidity are viewed as a single discipline, concerns about leverage and leverage ratios will be substantially mitigated.
The IIF report in particular insisted on the need to have broader collateral eligibility frameworks in cruise-speed, called for a greater transparency on the lender-in-last-resort operations, and suggested that central banks contribute to the testing of banks Contingency Funding Plans by “dry-runs” of last-resort operations.
A regression of U.A.E. three-month interbank rates on U.S. three-month interbank rates with monthly data for the January 2007–March 2009 period yields a coefficient smaller than one (0.68), thereby suggesting that there is some scope for independent monetary policy action.
Anecdotal information suggests that U.S. dollar/dirham foreign exchange swaps and forwards are substantially more liquid than straight dirham interbank unsecured loans. For instance, the daily turnover in the dirham unsecured interbank market is estimated in the Dh. 2-3 billion range, essentially on short-term tenors, while the turnover in the market for foreign exchange swaps is in the Dh. 4-7 billion range, with peaks up to 10 billion, and with a broader set of maturities being actually traded. This discrepancy suggests a fair degree of reliance on foreign banks for a smooth functioning of the market.
Funding shortfalls have been met through foreign borrowing and large public sector and wholesale deposits,
It should be noted, though, that even a deeper U.A.E. interbank market could have dried up during the crisis owing to counterparty risk perceptions.
In an excess liquidity environment banks holding larger excess reserves than others are sanctioned by an opportunity cost of keeping idle cash that is any case bound by zero. In a liquidity shortage environment the treasurer falling repeatedly short of reserves on its account with the central banks (overdraft) generally has to pay large penalty rates, bears a reputational costs and sometimes undergo higher supervisory scrutiny (because inefficient liquidity management may be a leading sign of mismanagement for supervisors). This highlights a fundamental asymmetry of incentives between liquidity surplus and shortage environments.
Banks tend to plan more carefully their cash flow patterns, and determine more carefully their demand for idle cash balances, when they are at risk of running an overdraft on their account with the central bank.
See “Principles for Sound Liquidity Risk Management and Supervision,” Basel Committee on Banking Supervision (September 2008).
Such restrictions were part of these measures in the U.A.E. since the conditions attached to the first (AED 50 billion) liquidity support package provided that the liquidity relief should not be used to expand credit, and urged beneficiary banks to fall back into line within 3 months. See for instance, Standard Chartered Bank “U.A.E.: fixing liquidity,” November 2008, and “GCC, pro-cyclicality, recession and the way out,” February 2009.”
See also Boyd, De Nicolo, and Jalal (2009) who found a similar trend for U.S. banks in 2003 and for banks in 134 nonindustrialized countries for the period 1993-2004.
The definition of loans to deposits used here is not exactly the same as the one used by the CBU.
It is interesting to note that in most other countries the supply of high-quality risk-free securities in a context of banking crisis is countercyclical, as the involvement of the government in managing the crisis brings about short-term fiscal shortfalls that have to be financed via debt issuance, thus increasing the supply and hence the relative amount of debt securities in the system.
And also administratively cumbersome for commercial banks.
In addition to sterilization motives, there are several arguments for providing public debt instruments beyond meeting governments funding needs, including: (i) for ensuring a sufficient supply of high-quality (liquid) assets; (ii) fostering the development of the market for corporate bonds and short-term debt and providing the basis for a yield curve; and (iii) jump starting the secondary market for fixed income securities via the creation of repo and security lending markets. In the case of Australia for instance the decision to “overfund” the public debt and keep on issuing in the context of rising fiscal surpluses was based on (i) the intention to provide a risk-free yield curve to facilitate the pricing of private sector debt instruments (i.e. not “closing the government debt market”); and (ii) the need to create a cushion to brace for expected future fiscal shortfalls.
T-Bills issuance for sterilization purposes are successfully used in Uganda and Tanzania.
When the government issues the treasury bills, it incurs interest expenses. These could be borne either by the government or the central bank, if the latter has enough seignorage or its financial position is otherwise sufficiently sound.
The calibration of this portfolio should be done on the basis of the usual volatility of autonomous factors (Treasury account, bank notes, seasonal drains on FX reserve), so that the targeted size of the portfolio would, for example, cover 2 standard deviations of autonomous factors’ daily changes. A two standard deviation confidence interval would permit to absorb 95 percent of daily potential shocks in autonomous factors. This portfolio could also be adjusted not only to absorb the “noisy” component of autonomous factors daily changes, but also adjusted on a monthly or quarterly basis to reflect well-established balance of payments seasonal trends.
It is worth noting that in this case the Treasury would have to support a counterparty risk that ought to be monitored and contained, either by a tight selection of counterparts and or by the use of collateralized operations (based on non-government collateral) and other risk mitigation techniques (concentration limits, margin calls, collateral substitution, etc.).
In the spring of 2009, the U.A.E. announced that it would not participate in the GCC Monetary Union project. Longer-term prospects are still uncertain though, as it is likely that a regional monetary union would still represent an important regional anchor, and certainly serve to catalyze further regional financial integration to which countries outside the union may not be completely immune. In addition, there would be competition between Gulf countries financial systems to improve their market infrastructures.